ACCT 4310 Audit Final Exam Class Notes

IR X CR X DR

AR =

Scope Limitations (Diagram)

Is it material, pervasive?: Similar to previous slide on departure from GAAP. Immaterial: We do not need this evidence to be able to give the opinion. Pervasive: If it is pervasive, we cannot offer an opinion. Alternative Procedures Available: If there is other ways to get this information/evidence, and we do so, we can still offer an unqualified opinion. Ex.) Using subsequent cash receipts instead of a confirmation.

Disclaimer of Opinion (Scope of Limitations)

Is the Scope Limitation Material? "Yes". Are there alternative procedures available? "No" Is the scope limitation pervasive? "Yes"

Qualified Opinion (Scope Limitations)

Is the Scope Limitation Material? "Yes". Are there alternative procedures available? "No". Is the scope limitation pervasive? "No"

Unqualified Opinion (Standard Report) (Scope Limitations II)

Is the Scope Limitation Material? "Yes". Are there alternative procedures available? "Yes".

Attorney (Role of Various Parties in Audit of Litigation, Claims, and Assessments)

Responsibilities: Respond to auditors regarding client's description of litigation, claims, and assessments contained in the attorney letter.

One step above individual completing work (initial), Engagement Partner, Independent Partner/Quality Control

Review of workpapers - by who?

Unqualified Report (Standard Report) (Audit of Group F/S)

Take Responsibility for Component Auditors' Work in a Group F/S? "Yes"

Lot of (Pick One Choice)

There are a (lot of/few) accounts affected by the Revenue and Collection Cycle.

Historical Cost, Fair Market Value, Net Realizable Value

Three different ways something can be valued.

Existence, Valuation, Completeness (Fill-In)

Two Major Assertions for Inventory: _______________ and ______________. Maybe sometimes ___________________ of inventory is a concern because Inventory entries include COGS, Revenue, and A/R so the lower inventory may be from a fictitious transaction to increase revenue. There could also just be errors in the inventory account because there is a lot of movement within the inventory.

Treatment of Subsequent Events

Type I would involve an adjustment to the Financial Statements (Reflected in Financial Statements/Reported). Type II does not affect the financial statements, but since it affects them going forward, we would disclose this event/information.

Positive Confirmations

Type of Confirmation. Small number of accounts are involved. Large number of errors are anticipated.

(Typically) Low Risk unless a History of Misstatements

What are inherent risks of Expenses?

Indicate Division of Responsibility in Unmodified Opinion (Audit of Group F/S)

Take Responsibility for Component Auditors' Work in a Group F/S? "No". Do they refer to component auditors by name? "No".

Obtain Permission and Present Component Auditors' Report (Audit of Group F/S)

Take Responsibility for Component Auditors' Work in a Group F/S? "No". Do they refer to component auditors by name? "Yes".

Audit Supervisor

Who completes this part of the Audit Documentation Review?: Have all steps in audit plan been performed?; Is referencing among documentation clear?; Are explanations understandable?

Audit Manager and Partner

Who completes this part of the Audit Documentation Review?: Is the overall scope of the audit adequate?; Do overall conclusions support the opinion?

Reviewing Partner

Who completes this part of the Audit Documentation Review?: Is the quality of audit work and reporting consistent with quality standards of the firm?; Engagement quality review

Authorization of Transactions (Key Control Procedures for Revenue and Collection Cycle)

Write-offs; EDI transactions; Credit checks prior to approval of sale; Pricing

Cutoff (Fill-In)

When we talk about ____________ in terms of Revenue, there are multiple components. You may be looking at the occurrence of revenue, but this also depicts the completeness of AR.

Property, Plant, and Equipment

A big concern is Existence since it is an asset, Valuation is another concern due to it being a Net Book Value (We want to ensure depreciation is correct). You would have a Roll-Forward from last year (look at last year's value; see the new additions, disposals, and the increase in depreciation; and make sure the balance is correct). If there are additions, we would vouch that those have been purchased by looking at supporting evidence. For disposals, go out and look at items and make sure they have not been disposed of from the listing or you could do inquiry to lead you the right direction. Ask people involved with operations, outside of the accounting department, what new equipment do you have and what machines did you sell or dispose of. For Depreciation, you would most likely recalculate it to ensure that what is recorded is consistent with that.

Roll-Forward Procedures

Extend work from interim period to date of the financial statements: (1) Include both tests of controls and substantive procedures, (2) Performed following date of the financial statements, (3) Idea is to obtain evidence through the date of the financial statements

Income Taxes Payable

Extremely complex area (Client may operate in multiple tax jurisdictions). Usually requires tax specialist. Vouch payments. Examine correspondence with government agencies. Follow standard for auditing estimates.

Possible Misstatements of Revenue

Fictitious Sales or Customers (Related to Occurrence), Other Fraudulent Activity (Channel Stuffing), Incorrect Amounts, Incorrect Periods

Potential Misstatements for A/R

Fictitious Sales/Customers, Inadequate Allowance for Doubtful Accounts, Might have Sold off Rights to Collect A/R

Group Financial Statements

Financial statements comprised of more than one division/subsidiary/segment/component.

Adverse Opinion ("Do Not Present Fairly")

Financial statements not presented fairly, materially misstated.

Completeness, Existence (Fill-In)

Floor to Sheet Tests ___________________, Sheet to Floor Tests _________________.

Auditing the Purchasing Process

Focusing on Substantive Test of Details with the Purchasing Process (Cash Disbursement, Expenses). Lot of test of controls around purchases and Analytical Procedures (Percentage of Revenue, Percentage of Assets). Lot of testing on the front-end. Testing of Accounts Payable is the focus of this chapter.

Accounts Receivable (Analytical Procedures)

For "this", Is there a benefit to analytical procedures? Yes, it is a good efficient way to gain some assurance on the assertions related to this. What kind of analytical procedures would we consider? Reasonableness Test, Trends, Ratios? Past Year Trends? How has this account fluctuated over the years. Would be more likely to change predictably. Ratios would make a lot of sense, there are other components within the Financial Statements that this would be tied to. (Allowance for Doubtful Accounts and Bad Debt Expense [Valuation], Sales [Existence, Percentage of Sales may be reasonable].

Develop an Expectation, Define a Tolerable Difference, Compare Actual to Expected

For Analytical Procedures: (Step 1) ______________ ____ ______________ [By Using Trends such as how has revenue usually changes over time, By Industry Average if you are usually in line with the industry average, By Documenting Ratios such as ratios related to inventory and COGS, By Information We Have the hotel case we did where we had information related to the revenue expectations], (Step 2) ___________ ___ ____________ _____________, (Step 3) _____________ _____________ _____ _______________.

Disclosure (III)

For Contingent Liabilities, Is it estimatable? "No" Is the Likelihood Remote, Reasonably Possible, or Probable? "Probable"

Disclosure (II)

For Contingent Liabilities, Is it estimatable? "No" Is the Likelihood Remote, Reasonably Possible, or Probable? "Reasonably Possible"

Do Nothing (II)

For Contingent Liabilities, Is it estimatable? "No" Is the Likelihood Remote, Reasonably Possible, or Probable? "Remote"

Record/Adjust

For Contingent Liabilities, Is it estimatable? "Yes" Is the Likelihood Remote, Reasonably Possible, or Probable? "Probable"

Disclosure

For Contingent Liabilities, Is it estimatable? "Yes" Is the Likelihood Remote, Reasonably Possible, or Probable? "Reasonably Possible"

Do Nothing

For Contingent Liabilities, Is it estimatable? "Yes" Is the Likelihood Remote, Reasonably Possible, or Probable? "Remote"

Requirements of Revenue Recognition

Four Criteria: (1) Persuasive Evidence that an Arrangement Exists (Purchase Order), (2) Either Provided Service or Delivered Goods (Shipping Documents), (3) Price has to be Fixed or Determinable, (4) Reasonable Expectation to Collect

Management Representation Letter (Extra)

From management to auditors, includes anything significant (such as uncorrected misstatements) discussed during the audit.

Separation of Duties (Key Control Procedures for Revenue and Collection Cycle)

Separate functions for recording, authorization, custody.

Difference Between Type I and Type II Subsequent Events

Shed-Light on Something that Occurred Before Year-End OR Something that happens that effects the company going forward.

Access to Assets (Key Control Procedures for Revenue and Collection Cycle)

Shipping department and Lock box account

Audits of Employee Benefit Plans Subject to ERISA

Requires a new form of report specific to an audit of an ERISA plan when management imposes an ERISA-permitted audit scope limitation.

Positive Confirmations, Negative Confirmations, Blank Confirmations

Types of Confirmations

Circumstance-Imposed, Client-Imposed

Types of Scope Limitations

(Overview of the) Purchasing Process

"A purchase transaction usually begins with a *purchase requisition* generated by the user department. The purchasing department prepares a *purchase order* that is sent to the vendor. When the goods are received, or the services rendered, a *liability is recorded* (As well as the expense). Finally, the entity *pays the vendor*."

(We are typically more concerned with) Understatement

Are we more concerned with understatement or overstatement of A/P?

(We are Typically More Concerned with) Overstatement

Are we more concerned with understatement or overstatement of A/R?

Three Reasons to Depart from Unqualified Opinion

(1) *Departures from GAAP*, (2) Scope limitations, (3) Audit of group financial statements. However, they should not include Audit of Group Financial Statements as a reason to depart from Unqualified Report (This would just be an adjustment to the Unqualified Opinion), AND they should also include a lack of independence as another reason to depart from standard unmodified opinion (Over the course of the audit, an independence issue appears or is detected).

Procedures Performed During Fieldwork

(1) Completing substantive procedures, (2) Attorney's letters, (3) Written representations, (4) Going-concern assessment, (5) Adjusting entries, (6) Audit documentation review, (7) Subsequent events, (8) Subsequently discovered facts

Analytical Procedures

(1) Sales Revenue (Comparisons with previous periods, Comparisons with industry); (2) Allowance for Doubtful Accts, Bad Debt Expense (Bad Debt Expense as a percentage of Sales, Allowance for Doubtful Accounts as a percentage of Gross Receivables; (3) Accounts Receivable (Days Sales in Accounts Receivable, Accounts Receivable Turnover)

Procedures Following Audit Report Release Date

(1) Subsequently discovered facts; (2) Omitted procedures; (3) Communication with those charged with governance; (4) Management letters

Auditing Accounts Receivable

(1) Test Accounts Receivable Aged Trial Balance, (2) Confirm balances, (3) Perform analytical procedures, (4) Test sales cut-off

The Standard (Unmodified) Report (Other Elements)

(1) Title includes the word "independent"; (2) Addressed to the client (normally, shareholders and board); (3) Dated when auditors have obtained sufficient appropriate evidence (date of the auditors' report); (4) Signed by the accounting firm.

Types of Opinions

(1) Unmodified opinion (F/S are in accordance with GAAP; Standard report may be modified to disclose additional matters. (2) Qualified opinion ("Except for" some matter, F/S are in accordance with GAAP). (3) Adverse opinion (F/S are not in accordance with GAAP). (4) Disclaimer of opinion (No opinion is issued by auditors)

Alternative Procedures

(1) Vouch subsequent cash collections (usually sufficient evidence of existence, valuation); (2) Examine shipping documents (Especially BOL (third-party evidence)); (3) Examine client-generated supporting documentation, such as invoices (Depends on internal controls); (4) Inspect correspondence files

Using the Audit Risk Model

(1.) Set audit risk at desired levels (normally, low). (2.) Assess risk of material misstatement, which incorporates inherent risk based on the nature of the account balance or class of significant transactions and control risk based on gaining an understanding of internal control. Note that AS 2110 indicates that the auditor should [presume that there is a fraud risk involving improper revenue recognition. (3.) Set detection risk at the significant account and assertion level based on the level of audit risk and risk of material misstatement.

Basic Activities in Revenue and Collection Cycle

(1.) receiving and processing customer orders (Revenue Cycle is initiated by an Order from the customer; We process the order); (2.) delivering goods and services to customers (We deliver goods to the client); (3.) billing customers and accounting for accounts receivable (We then bill the customer); and (4.) collecting and depositing cash received from customers (The customer makes a payment to us for the goods).

Types of Written Communication During the Audit

4 Types of Communication: (1) Engagement Letter (To Client (Management) From Auditors; Its purpose is to Set Out the Arrangement for the Agreement [Acts a Contract] and can also be used to limit liabilities [what are the responsibilities]); (2) Management Representation Letter (From Management to Auditors; Used to put in writing any implicit representation, or verbal representations throughout the audit); (3) Significant Deficiencies and Material Weaknesses for internal controls have to be shared in writing to those in Governance [To Audit Committees and Management and Board of Directors from Auditors]; (4) Management Letter [Not Required Under Audit Standards] (From Auditors to Management; Gives suggestions for improvement [communicate ordinary control deficiencies, operational deficiencies]).

AR

= IR X CR X DR

Separation of Duties

A Control Procedure for Expenditures and Accounts Payable: Authorization of the purchase is done by the purchasing department. Custody of the inventory item(s) is held by the receiving department and, ultimately, the requesting department. Transactions are recorded by general accounting (control account) and accounts payable department (subsidiary accounts). Reconcile liabilities to customer statements and general ledger account. Bids are received by someone independent of the purchasing decision.

Information Processing Controls

A Control Procedure for Expenditures and Accounts Payable: Compare PO number on BOL with company PO. Compare quantities against receiving report and purchase order. Compare prices against quoted price or catalog listing. Recompute vendor's invoices. Determine when to pay invoice. Properly prepare voucher.

Performance Reviews

A Control Procedure for Expenditures and Accounts Payable: Compare purchases data to data from previous years or expected purchases data. Review bids to ensure that documentation exists regarding the selection of the vendor.

Contingent Liability

A liability that is contingent (depends) on a future event (either happening or not happening).

Fraud (Fill-In)

A lot of focus is on ___________, the fact that management has incentive to overstate revenue (inflate performance measures to help their ownership in the company, or there compensation contracts may be dictated by performance). However, there are a lot of unintentional aspects of errors due to revenue recognition. Some companies have complex revenue recognition processes.

Audit of Group Financial Statements

Accept responsibility for work done by other auditors, we can still file a standard report. If we choose not to accept responsibility for them, we can name them (provide name in audit report and present their report accompanying ours in the filing) or we can split responsibility and state that this step was done by a different auditor.

Net Realizable Value

Accounts Receivable are recorded at...

Accounts Payable Confirmations

Accounts payable confirmations *are used less often than accounts receivable confirmations*. The auditor is able to examine externally created source documents relating to accounts payable. When confirmations are used, they are usually positive and referred to as *blank confirmations*. The vendor is asked to supply the balance owed by the entity. A procedure you may see for testing accounts payable. These are used very infrequently because existence is not the high-risk area of payables, completeness is more difficult to gain an understanding from by confirmations. If they are used, they are usually blank confirmations and are sent to all vendors they have a history of using, even those who they say they have a zero balance with at the moment.

Dual Test

Acts as both a Test of Controls and a Substantive Test.

Consistency (Effect on Report)

Add emphasis-of-matter paragraph following the opinion paragraph. May issue a qualified opinion (GAAP departure) if: (1) Change is not justified; (2) Change is not accounted for in accordance with GAAP.

(Persuasive Evidence of an) Arrangement Exists

An SEC guideline for Revenue Recognition. We are trying to collect evidence that there is an arrangement that exists, we can examine the *Purchase Order* [document depicting the request of the customer to order] (For construction, might be more likely to be a long term contract).

(Seller's) Price (to the Buyer) is Fixed or Determinable

An SEC guideline for Revenue Recognition. We have to have a fixed and determinable price, we can examine the *Invoice or the Initial Purchase Order*, there could be long-term pricing agreement or a standard price. This can be different documents depending on the client.

Delivery (has Occurred or Services Have Been Rendered)

An SEC guideline for Revenue Recognition. We must know that delivery has occurred, we can examine the *Shipping Document such as a Bill of Laden* (preferably from a third-party delivery person if that is used). Look at when the goods are shipped and the terms of the shipment (FOB Shipping, Destination, etc.).

Valuation (Manufacturing Client) (Fill-In)

Assertions for Inventory? _______________ becomes the most important assertion for inventory. We would have a lot of recalculations of the valuation, such as looking at the overhead, how indirect costs are distributed to the valuations, etc.

Analytical Procedures, Substantive Procedures, Analytical Procedures (Fill-In)

Audit Standards require _______________ _______________ as part of the risk assessment early on (geared towards pushing us to high-risk areas). Ex.) Year over Year Comparison for an Account. As a __________________ _______________ (Analytical Procedure or Test of Details): These analytical procedures are not required by audit standards, but if we have the opportunity to more efficiently gather information using analytical procedures we should use them. (Can't declare a misstatement, but can point out where a misstatement may have occurred). At the end of the Audit: Audit Standards require _______________ _________________ at the end to try to look for something that is out of line with our expectations.

Going Concern

Clarifies that auditor's objectives include separate determinations with respect to (1) the appropriateness of management use of the going concern basis of accounting and (2) whether substantial doubt exists about an entity's ability to continue as a going concern. Requires auditor to obtain sufficient appropriate evidence regarding future financial support if such support is necessary for management's assertion about going-concern. Requires auditor to inquire of management regarding conditions and events beyond the period of management's evaluation that may impact the entity's ability to continue as a going concern. Provides various reporting options for explanatory paragraphs, depending upon whether (1) management's plans alleviate the substantial doubt regarding going concern and (2) the entity's financial reporting framework requires disclosure of the existence of substantial doubt.

Tests of Details for A/R

Confirmations (If we can confirm with the customer that they owe that balance, that is good evidence) [Know the different types, expectations, values right/wrong, reliability] {One concern is non-response}; Looking at Subsequent Cash Receipts (Look at money received if you could not gain a confirmation); Looking at Supporting Documents; Come Up with Our Own Independent Estimate of Allowance for Doubtful Accounts; Observe Board Minutes.

Comparative F/S

Continuing auditors: (1) Report should address all years presented in comparative form; (2) Update opinion by considering if previously issued opinions still appropriate; (2) If previously issued opinions not appropriate, revise opinion in current report (other-matter paragraph). Predecessor auditors: (1) With permission, auditors may present reissued report from predecessor on prior years' F/S along with successor's report on current F/S; (2) If predecessors' report not presented, successor auditors' report must reference predecessors' report and opinion on prior years' F/S (other-matter paragraph).

(1) Information Processing Controls, (2) Separation of Duties, (3) Physical Controls, (4) Performance Reviews

Control Procedures for Expenditures and Accounts Payable

Type I Subsequent Event (Example)

Customer Bankruptcy: Customer declining financial position, or Client Declining Financial Position; Litigation or Warranties or Tax Disputes (Contingent Liabilities)

Bill and Hold (Revenue; Inherent Risks)

Customer Orders the goods, we will bill them for it, but don't ship until January: You have not delivered the goods, no revenue recognition.

Electronic Data Gathering, Analysis, and Retrieval System (EDGAR)

Database of all fillings of Public Companies (Registered with SEC). 10-Q with Quarterly Financial Statements are Reviewed not Audited. Item 8 of 10K: Financial Statements.

Summary Financial Statements

Derived from the full set of financial statements. Auditor can only examine and report if audited full financial statements. Report: (1) Refers to auditors' report on full financial statements; (2) Indicates whether information in summary financial statements is consistent in relation to the full financial statements.

Effect on Report (Group F/S)

Group auditors should: (1) Verify component auditors' reputation and independence, (2) Communicate and coordinate with component auditors. Options: (1) Take responsibility for work: Standard (unmodified) report; (2) Name component auditors. Present report of component auditors, only with their permission: Refer to component auditors. Modify Auditor's Responsibility section. Modify opinion paragraph. Still express unmodified opinion, if appropriate.

Completeness (Accounts Payable)

How do we test this? We are looking at the future use of an asset, anything we have to pay for in the future. The first source we look at are Cash Disbursements after year-end. A lot of liabilities at Dec. 31 will have to be paid in the near future.

Can either adjust report date to include date of subsequent event or dual date (Dual dating limited liability to identified event, changed date liable for all).

How does subsequent event affect audit report date?

(1) New Format (Opinion and Basis for Opinion (no longer intro, scope, and opinion paragraphs)); (2) Critical Audit Matter ("CAM"); (3) Statement about how long they have been the auditor

How has/will the audit report change?

Subsequently Discovered Facts

If discovered prior to audit report release date, perform procedures related to items: (1) Revise date of auditors' reports to reflect new completion date, (2) Dual date auditors' reports. Following audit report release date: If facts would result in revision of auditors' report or F/S and individuals are relying on F/S: (1) Notify individuals relying on F/S, (2) Issue revised F/S which provide disclosure of facts.

General Approach for Other Matters

Issue unmodified opinion but add paragraph to report to discuss the matter: (1) Emphasis-of-matter paragraphs provide information related to users' understanding of F/S; (2) Other-matter paragraphs provide information related to users' understanding of audit, auditors' responsibility, or auditors' report. Situations: (1) Consistency; (2) Going-concern (When we have concerns that are not successfully addressed by management about their ability to continue on in the future & refer to management's financial footnote on their supposed solutions); (3) Other Information; (4) Required Supplementary Information; (5) Emphasis of a matter.

Accrued Liabilities

Major differences between accrued liabilities and accounts payable (Examples include interest, property taxes, wages, and income taxes payable. These payables are not normally invoiced or evidenced by the receipt of goods). These differences may make it more difficult to detect unrecorded accruals.

Type II Subsequent Event (Example)

Natural Disaster (Lot of Destruction Damage due Fire or Tornado: Did not affect last years financial statements, but does impact the future. Mergers and Acquisitions Could be another subsequent event.

Auditor Search Database

New Auditing Standards now have AP (Audit Participation) Items; Includes those on the audit, partners of the firms who did the audit, etc.

Form AP (Identify engagement partner and other firms completing work).

New form filed with PCAOB by auditor?

Management (Reports Accompanying Financial Statements)

Nonpublic Entities: N/A. Public Entities: Effectiveness of internal control over financial reporting.

The Payroll Cycle

Often processed by service bureaus. Balance sheet accounts usually small. Rely on tests of controls/substantive tests of transactions.

Year-End Date

On the Audit Timeline, Complete the Bulk of the Substantive Procedures, and *Lots of Other Things*

Date of the Auditor's Report

On the Audit Timeline, Have completed enough procedures and received enough evidence and information to be able to form an opinion.

Test of Details of Transactions, Account Balances, and Disclosures: Disclosure Items for the Purchasing Process

Payable by type (trade, officers, employees, etc.). Short- and long-term payables. Long-term purchase contracts, including any unusual purchase commitments. Purchases from and payable to related parties. Dependence on a single vendor or a small number of vendors. Costs by reportable segment of the business.

Physical Controls (Payroll Control Activities)

Payroll Control Activity. Payroll Checks and signature plates kept in a secure location. Payroll Checks distributed by a person not involved in processing or recording payroll. Payroll checks distributed to individuals with proper identification. Unclaimed Payroll Checks stored in a secure location.

Performance Reviews (Payroll Control Activities)

Payroll Control Activity. Payroll transaction data compared to prior-year data or budgeted/expected data. Review of payroll register for reasonableness. Reconcile the payroll bank account.

Segregation of Duties (Payroll Control Activities)

Payroll Control Activity. The personnel department and the hiring/employing department authorize payroll transactions and payroll-related changes. Payroll is recorded by the payroll department and general accounting. The cash disbursements department/Treasurer has custody of the payroll checks.

Required step performed on final audited balances.

Perform final analytical procedures?

(Scope Limitation:) Disclaimer of Opinion

Pervasive scope limitation, usually client-imposed: Significance of the limitation is such that auditors cannot gather sufficient appropriate evidence to form an opinion. Report Modifications: (1) Introductory paragraph: ("We were engaged to audit ...."); (2) Modify Auditor's Responsibility section: [Note that auditors were not able to obtain sufficient appropriate evidence. Delete paragraphs describing an audit and indicating that the audit provides a basis for the opinion]; (3) Add paragraph preceding the opinion paragraph describing the scope limitation; (4) Modify opinion paragraph ("...we do not express an opinion....")

Returns and Allowances (Revenue; Inherent Risks)

Possibility of goods being returned to us.

Adequate Documents and Records (Key Control Procedures for Revenue and Collection Cycle)

Pre-numbered sales orders, shipping documents (bills of lading), sales invoices and Remittance advice

Consistency

Relates to: (1) Change in accounting principles; (2) Adjustments to correct misstatements in previously issued F/S. Type of changes in accounting principles: (1) Accounting principles (GAAP to GAAP); (2) Form of reporting entity; (3) Accounting principles (non-GAAP to GAAP); (4) Accounting principle inseparable from changes in estimates

Completeness, Cutoff, Existence, Presentation, Valuation

Relevant Assertions for Accounts Payable

Existence, Completeness, Valuation

Relevant Assertions for Auditing Accounts Receivable

Occurrence, Completeness, Cutoff

Relevant Assertions for Auditing Revenue

Completeness, Cutoff, Accuracy, Classification

Relevant Assertions for Various Expenses

Lack of Independence

Scenario: Auditors begin engagement but independence subsequently compromised. Report: (1) Single paragraph; (2) Indicates auditors are not independent; (3) Does not indicate why independence lacking.

Client-Imposed (Scope Limitation)

Situation in which client specifically limits auditors' procedures. Should be viewed as a significant restriction and a disclaimer is ordinarily issued. The clients are not giving to us or allowing us to access this evidence. (This should be a red-flag that usually leads to a disclaimer of opinion, but still go through the decision tree). Ex.) Not giving us a representation letter.

Floor to Sheet and Sheet to Floor

Test both directions. What is out in the warehouse or on hand and count it and make sure it agrees with what is on the "sheet" (the financials our general ledger) SINCE YOU ARE TRACING WHAT IS OUT THERE TO WHAT IS ON THE SHEET, FLOOR TO SHEET TESTS COMPLETENESS. When we go from sheet to floor we look at the recorded amount and count to see if the floor inventory actually exists, so we are vouching SHEET TO FLOOR TESTS EXISTENCE.

Test of Details for Accounts Payable: Completeness

The auditor should conduct a *search for unrecorded liabilities* that includes the following: 1.) Ask management about *control activities used to identify unrecorded* liabilities and accruals at the end of an accounting period. These controls should be *part of the closing process*. ("Key aspect because the company should have procedures in place to ensure these liabilities are recorded; they go through receiving reports to see if they have a liability that should be recorded in previous year after year-end") 2.) Vouch *cash disbursements journal for a limited time after year-end*: examine the date on each receiving report of vendor invoice to determine if the liability relates to the current audit period. 3.) Examine *unpaid invoices* for any liabilities related to year under audit. ("Invoices that have still yet to be paid when we get out to the client. We look to see if they are for liabilities that should have been recorded in the previous year") 4.) Examine the files of *unmatched purchase orders, receiving reports, and vendor invoices* for any unrecorded liabilities. ("Items that the full voucher packet has not been assembled for yet, such as missing an invoice for goods that have been requested and received"). Do these cash disbursements relate to liabilities that were owed at or before December 31. We look at all payments from January 1 to the current day that we are testing on, the documents of these payments, and what is being paid and for what. Any payments that we can distinguish that should have been recorded as a liability, we will then look for that liability in the Accounts Payable listing, and we will decide if it was recorded correctly, or if not recorded why the company may have missed that liability [such as not receiving the invoice yet]).

(1.) receiving and processing customer orders; (2.) delivering goods and services to customers; (3.) billing customers and accounting for accounts receivable; and (4.) collecting and depositing cash received from customers.

The basic activities in the revenue and collection cycle for a typical manufacturing company include:

Negative Confirmations (Not Common in Practice)

The combined assessed level of inherent and control risk is low. A large number of small balances is involved. The auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration. "Scenarios for these could be when risk of material misstatement is low or we have a large number of small balances."

Cutoff Test (Within PCAOB, testing both COMPLETENESS and EXISTENCE/OCCURRENCE)

The cutoff test attempts to determine whether all revenue transactions and related accounts receivable are recorded in the proper period. Happens at the same time of testing of inventory. (You will do a cutoff test for inventory, A/R (Inv. Going out), and A/P (Inv. Coming in). Test of Details: Typically involves looking at last 5 shipments before year-end and first 5 shipments of new year (unless there is a lot of inventory, then a larger number of shipments would be tested. You would look at the shipping documents to see what was shipped and what the terms were.

Changes to Audit Report

The report utilizes section headings to guide readers to important elements within the report. The auditors' opinion is stated at the beginning of the report (first paragraph), rather than at the conclusion of the report. The discussion of auditors' responsibility has been revised to specifically identify the auditors' independence requirement. The description of the audit has been revised to indicate that auditors are required to assess the risk of material misstatement (whether due to error or fraud) and perform procedures related to the risk of material misstatement. The auditors are required to specifically identify critical audit matters within the report. The report will contain a statement disclosing the year in which the auditor began serving as the company's auditor.

Historical Cost, Fair Market Value, Net Realizable Value (Fill-In)

Three different ways something can be valued: (1) _____________ _________ - Most common, the initial cost. (2) ______ ___________ __________ - We can value things on the balance sheet at fair value, such as investments. (1&2A) Some Can Use Either Depending, ex.) Inventory is at lower of cost or market. (3) ________ ______________ _________ - Gross Amount of A/R less Allowance for Doubtful Accounts (A for DA is a Contra-Asset Account).

High (Fill-In)

Unless we test Control Risks, Control Risk has to stay __________.

Collectability of Receivables (Revenue; Inherent Risks)

Us not having the ability to collect on some accounts (BDE and Allowance for Doubtful Accounts).

Disclaimer of Opinion ("No Opinion")

We cannot determine/state the financial reports are fairly presented or not.

Alternative Procedures Related to Confirmations

When we are sending out confirmations, we may not have great response rates. If you don't get a response, the typical response is to send another one, if you don't get a response the second time you may send a third. IF YOU ARE NOT SUCCESSFUL IN CONFIRMING THESE BALANCES, you can look at Invoices or Shipping Documents or Something Similar. Invoices: You can look at them for some evidence the A/R exists but if there are not greatly effective Internal Controls, this internal document may not be very reliable. Shipping Documents: If you layer the invoice with the shipping document (If these documents are external this is a little more reliable), but if this is also internal there still may not be great reliability. If you are auditing after year-end, we can look to see if the A/R has been paid (Subsequent Receipts/Cash Collections) to see if they have been paid. THIS IS THE MOST RELIABLE. Timing is still a concern though, because this does not have evidence that this transaction occurred before or on Dec. 31 of the year being audited.

Confirmations Reliability

____________________ ______________ Can Vary Based On: (1) Attended Recipient: Are the clients individuals (not have records or less likely to respond) or corporations (have more detailed account records), (2) Type of Confirmation that is Sent: Positive (They will respond if the balance is correct, if it gets lost in mail we will then assume the balance is wrong) [More Helpful] and Negative (They will only respond if the balance is incorrect, this is less reliable) [Less Helpful] WITHIN POSITIVE, there is also a Blank Confirmation which will require the client to fill in the balance rather than stating it is correct, (3) You can also confirm individual transactions (did these transactions exist), if we were to perform this confirmation we are not only gaining evidence on the existence of A/R but the occurrence of Revenue (A dual-test).

Auditor (Reports Accompanying Financial Statements)

"Nonpublic Entities": Fairness of financial statements and related disclosures. "Public Entities": Fairness of financial statements and related disclosures. Effectiveness of internal control over financial reporting.

Auditing Accrued Liabilities and Prepaid Expenses

(1) Agree balances to prior year workpapers; (2) Verify payments; (3) Examine underlying agreements; (4) Recalculate amounts (Agree expense accounts to trial balance); (5) Search for unrecorded accruals (Review cash disbursements at year-end. Look for expected accruals at other stages of the audit (bonds, notes, employees paid on 15th, etc.)); (6) Analytical Procedures

Inherent Risks in the Payroll Cycle

(1) Ghost employees; (2) Overpaying (padding) for time or production; (3) Incorrect accounting (classification); (4) Failure to pay third-parties (e.g. payroll taxes, insurance)

Control Procedures for Expenditures and Accounts Payable

(1) Information Processing Controls, (2) Separation of Duties, (3) Physical Controls, (4) Performance Reviews

Completeness Assertion (Search for Unrecorded Liabilities)

(1) Inquire about procedures for identifying and recording liabilities, (2) Scan open purchase order file, (3) Examine unmatched vendor statements or invoices, (4) Examine unmatched receiving reports occurring near year-end, (5) Trace unpaid vouchers in accounts payable ledger to receiving reports, (6) Confirm account payables with normal suppliers (even those with zero balances), (7) Review cash disbursements occurring after year-end

Modifications to Audit Report

(1) Matters that either result in a modified opinion or provide explanatory language are disclosed in a paragraph(s) immediately following the first paragraph of the Opinion on the Financial Statements section. (2) When disclaiming an opinion, the section titles are modified to Disclaimer of Opinion on the Financial Statements and Basis for Disclaimer of Opinion to emphasize that an opinion is not being expressed by the auditors. (3) The Critical Audit Matters section is not included when an adverse opinion or disclaimer of opinion is issued to reduce the likelihood that this section will distract report users from the serious nature of the auditors' opinion.

Audit Evidence in Management Reports and Data Files (Expenditures and Accounts Payable)

(1) Open purchase orders, (2) Unmatched receiving reports, (3) Unmatched vendor invoices, (4) Accounts (vouchers) payable trial balance, (5) Purchases journal, (6) Fixed asset reports

Audit Evidence in Management Reports and Data Files (Revenue and Accounts Receivable)

(1) Pending order and back order master file, (2) Customer master file, (3) Price list master file, (4) Sales detail (journal) file, (5) Sales analysis report, (6) Accounts receivable listing and aging, (7) Cash receipts listing Customer Statements

Payroll Cycle: Activities

(1) Personnel authorization forms are used to authorize all payroll-related transactions. Employees should record their hours worked using time sheets. (2) Supervisory personnel review time sheets and verify the distribution of hours worked on various jobs. (3) Payroll department processes payroll and prepares a payroll register and payroll checks. (4) Cash disbursements/Treasurer should review the payroll register and compare it to the payroll checks. (5) Payroll checks should be signed by an authorized party and distributed directly to employees.

(Payroll Cycle:) Management Reports and Files

(1) Personnel files, (2) Payroll register, (3) Labor cost analysis, (4) Clearing accounts, (5) Government and tax reports, (6) Year-to-date earnings records, (7) W-2 reports.

Other Accounts in Cycle (Expenditures and Accounts Payable)

(1) Prepaid Expenses (2) Accrued Liabilities, (3) Expenses, (4) Inventory, (5) Property, Plant, and Equipment

Basic Activities in Acquisition and Expenditure Cycle

(1) Purchase Goods and Services, (2) Receiving the Goods or Services, (3) Recording the Asset or Expense and Related Liability, (4) Paying the Invoice through the Cash Disbursement Process

Accounts Affected (by the Purchasing Process)

(1) Purchase: Dr. Inventory; Cr. Accounts Payable. (2) Cash Disbursement: Dr. Accounts Payable; Cr. Cash. (3) Purchase Return: Dr. Accounts Payable; Cr. Inventory. A lot of this is tested hand-in-hand with inventory. Especially looking at year-end with the Cutoff Statements to ensure these entries are recorded in the right year for both Purchases and Inventory.

Types of Purchasing Documents and Records

(1) Purchasing Requisition: Request to purchase goods or services. (2) Purchase Order: Includes description, quality, and quantity of goods or services being purchased. (3) Receiving Report: Records the receipt of goods. (4) Vendor Invoice: The bill from the vendor. (5) Voucher: Services as the basis for recording a vendor's invoice. (6) Voucher Register/Purchases Journal: Used to record vouchers for goods and services. (7) Accounts Payable Subsidiary Ledger: Includes amount owed to individual vendors. (8) Vendor Statement: Represents the purchase activity with vendor. (9) Check/EFT - Pays for goods or services. (10) Cash Disbursements Journal/Check Register: Contains columns to record credits to cash and debits to accounts payable and cash discounts.

Receiving the Goods or Services

A Basic Activity in Acquisition and Expenditure Cycle. After vendor approval, goods are received by company and evidenced by preparing a receiving report.

Purchase Goods and Services

A Basic Activity in Acquisition and Expenditure Cycle. Department requesting purchase of item(s) prepares purchase requisition. Bidding may be required on high dollar purchases. Purchasing prepares a purchase order approved by the appropriate person (usually dependent on dollar amount of purchase order). May be done electronically by EDI.

Recording the Asset or Expense and Related Liability

A Basic Activity in Acquisition and Expenditure Cycle. Vendor bills company for goods using a vendor's invoice.

Physical Controls

A Control Procedure for Expenditures and Accounts Payable: Prepare a receiving report upon initial receipt of inventory. Count and verify inventory quantities upon delivery to the inventory warehouse. Restrict access to inventories by keeping them in a secured location.

Independent Checks on Performance (Key Control Procedures for Revenue and Collection Cycle)

A/R subsidiary ledger to general ledger and Monthly statement to customer

Adjusting Entries and Financial Statement Disclosure

Accumulate dollar effects of identified misstatements. Evaluate materiality: (1) Rollover method considers the current period income effect(s) of misstatements; (2) Iron curtain method considers the aggregate effect of the adjustments on the entity's balance sheet; (3) SAB 108 requires adjustments to be proposed if material under either approach. Recommend adjustment of all misstatements identified. Carry any uncorrected misstatements forward for consideration in future audits Communicate all adjustments and misstatements to audit committee or individuals charged with governance. "This all revolves around materiality. We recommend adjustment of all misstatements identified, management has the decision of whether or not to make those adjustments (some they have to make or we will not give an unqualified opinion), some they can choose not to and we can still provide an unqualified opinion. In the management representation letter, the adjustments they do not do will have to be disclosed. We don't propose the materiality of the misstatements, we allow the management to decide which ones are material. If we then decide that we will be unable to issue an unqualified opinion management can also then decide to make the adjustment. Adjustments will also be communicated to those charged with governance."

(Other Matters Related to) Confirmations

All confirmations returned by the post office as non-deliverable must be investigated. Responses to positive and blank confirmations provide more reliable evidence than negative non-responses. Recipients of accounts receivable confirmations might not report understatements. Auditors must have heightened professional skepticism for electronic responses (fax or e-mail) [Verify that the response came from an appropriate person at the employer]. Non-response to Positive/blank confirmation requests (Follow up with second and sometimes third requests. A lower than expected response rate could be indicative of fictitious customer accounts. Alternative procedures). Non-response to negative confirmation requests (Only limited evidence concerning financial statement assertions. Alternative procedures are not necessary for unreturned negative confirmation requests). Follow-up on all exceptions

Audit Reporting (Group Auditors)

Amends existing requirements regarding supervision, planning, documentation, and engagement quality review for situations involving referred-to auditors: (1) Lead auditor should obtain representation from referred-to auditor that referred-to auditor is appropriately licensed, (2) If referred-to auditor plays a substantial role in the lead auditor's report, the lead auditor should determine that the referred-to auditor is registered with the PCAOB, (3) Lead auditor should disclose the name of the referred-to auditor in their report.

Collectability is Reasonably Ensured

An SEC guideline for Revenue Recognition. Reasonable chance of collecting the payment, we can examine a *Credit Process (Credit Check, Examine the Credit-worthiness of the client, having credit limits)*.

Inventory

An account that can vary drastically across clients. You can have clients in service-oriented business where inventory is limited or may not exist. You can also have more inventory intensive industries, such as manufacturers. These inventories are important to the audit since they are such a large balance on the assets portion of the balance sheet. There is still further variety within these inventory-focused clients.

Analytical Procedures for A/R

Analytical Procedures are Useful. You could look at different ratios, such as industry averages or historical averages of the client. Looking at the value as a percentage of sales or a percentage of A/R.

Auditing Cost and Expense Accounts

Analytical procedures (e.g. sales commissions). Agree to related balance sheet account (e.g. depreciation). Substantive tests of transactions (e.g. purchases). Vouch detail (e.g. legal expense).

Block Chain

Another example of technology is Blockchain, which is tied to crypto currency. This is a distributed ledger that allows many people to contribute but also confirm information within it. Not really impacting accounting yet, used more in operations such as the food industry.

Yes; (1) Receivable Turnover and Days Outstanding, (2) A/R Aging Portions, (3) Bad Debt as % of Revenue, (4) ADA as % of A/R

Are analytical procedures useful for A/R, and if so, what are some common analyses?

(Typically) Overstatement (but could be either with the nature of inventory [Since it is connected to Sales, the understatement could be fictitious sales])

Are we more concerned with understatement or overstatement for Inventory?

(Typically More Concerned with) Overstatement

Are we more concerned with understatement or overstatement for Revenue?

Sufficient (Quantity), Appropriate (Quality)

Audit Standards: We need __________________ and _________________ Audit Evidence

(1) Test Accounts Receivable Aged Trial Balance, (2) Confirm balances, (3) Perform analytical procedures, (4) Test sales cut-off

Auditing Accounts Receivable

Going-Concern Uncertainties

Auditors are responsible to evaluate whether substantial doubt exists about ability of entity to continue in existence for one year beyond date of F/S. Options: (1) Add emphasis-of-matter paragraph following opinion paragraph (still unmodified opinion); (2) If serious uncertainty, may issue disclaimer of opinion; (3) Modified language must include the words substantial doubt and going concern.

Association with Unaudited F/S

Auditors permit use of name in communication including F/S. Issue disclaimer of opinion (one paragraph): (1) Do not mention auditing procedures performed; (2) Must identify any known departures from GAAP in the report; (3) Should cover all unaudited prior years' financial statements

(Ability to Continue as a) Going-Concern

Auditors required to consider whether evidence obtained during audit raises questions about ability to continue as a going concern. If concerns exist, evaluate management's plans to mitigate: (1) If concerns do not remain: No effect on report or financial statements; (2) If concerns remain: Disclose in F/S and modify auditors' report. "We have to evaluate whether or not the company will be able to continue their operations, using a timeline of one year. If the auditors believe the company will not last a year, that is a going-concern issue and they need to discuss with management what the plan is to mitigate these concerns. If concerns still stand after seeing their plans, that's when management is required to provide a disclosure in the financial statements and the auditors will add this as a fourth paragraph of the audit report."

Other 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/disagreements encountered during audit (Ex. Different Opinions on Accounting Treatments/Estimates/Communication). Uncorrected misstatements (Identified by Auditors, Management Chose not to Correct [Under Material Threshold])*. Disagreements with management. *Material, corrected misstatements. Representations requested from management (Relates to Management Representation Letter)*. 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. "These are the other topics that must be communicated to individuals charged with governance, though they do not need to be in writing, due to their importance, they usually are included in the letter alongside the material weaknesses and significant deficiencies."

(1) Purchase Goods and Services, (2) Receiving the Goods or Services, (3) Recording the Asset or Expense and Related Liability, (4) Paying the Invoice through the Cash Disbursement Process

Basic Activities in Acquisition and Expenditure Cycle

Channel Stuffing (Revenue; Inherent Risks)

Bumping up revenue transactions by shipping out items that have not been ordered in the current period.

Retail Client

Buys goods at low price and sells at a higher price. Inventory on their balance sheet is usually recorded at the "lower of cost or market" (so usually historical cost). Example of When Market May be Lower is Technology items such as older iPhones.

Emphasis of a Matter

Call user attention to important matters. Add emphasis-of-matter paragraph after opinion paragraph discussing the matter.

Factors that Affect Inherent Risk of Revenue

Characteristics of the Client and their Operations: Size of the Client (More Volume, Greater Risk), Incentives and Pressures on Management to Meet Certain Benchmarks, Industry Factors (Industry Specific dictation of types of transactions)

Attorney Letter

Client Prepares the "this", they say which potential litigations they disclosed to auditors, and they want to know the estimate and probability of these litigations. The auditors then send the prepared attorney letter and receive the response. The response will confirm the information provided, alert other potential litigations, and whether the estimates and probability measures of the attorney differ from management. A concern is that the client may have engaged multiple attorneys, but only alert us of one or a few of their attorneys they have engaged about potential litigation. (Ex. You can check to see if other attorneys may have been paid).

Group Auditors

Conduct audit of material portion of the entity.

Evaluating the Audit Findings

Do Misstatements Exceed Tolerable Misstatement? Yes -> Qualified or Adverse. No -> Fairly presented but proposed adjustments will be assessed in total from all areas and evaluated based on Planning Materiality.

Unqualified (Unmodified) Opinion, Qualified Opinion, Adverse Opinion, Disclaimer of Opinion

Different Types of Audit Reports

Compile detected known and likely misstatements, propose adjustments, evaluate uncorrected misstatements and materiality.

Evaluation of Results?

Drones

Ex.) Auditors began using drones on their audits in agricultural settings, but now they are also being used in inventory counts. Some of the wording around the standards of inventory counts needing to be done by an audit personnel, so can they have the drone pilot do the count? The general consensus is that we do not need to address every technique or technology, but just have a more generalized wording of the standards to conform to the principles but be able to use technology with enough professional skepticism. Other ways in which drones could be used? (Reliability will still have to be taken into consideration). Inventory in Warehouses: Some inventory is high-up on shelves or is a large enough foot space that an aerial view would be more helpful. Concerns: There could be empty boxes that you are taking a picture of and other issues. Make sure that you have professional skepticism, a questioning mind.

Verify Cut-Offs for Purchases (Purchase Cutoffs)

Examine receiving reports and vendor sales invoices occurring around year-end to ensure inventory received is included in the appropriate period.

Audit Data Analytics (ADA)

Example of Technology which is used to process a lot of data for the audit. They also talked about artificial intelligence. Another technology is robotic process automation (RPA), which is one of the biggest transforming technologies being implemented right now. RPA: When you use excels you may use macros, which allow you to automate processes based on some kind of logic. RPA are basically like excel macros that are not bound by a single application. This macro can complete processes across everything on your computer. Can complete data manipulation, send mass emails to customers, and other audit tasks.

Accounting Estimates

Examples include future cash flows in evaluating asset impairments, allowance for doubtful accounts for receivables, and depreciation lives for fixed assets. Review management's process for developing estimates. Review estimates for reasonableness

Auditing Accounts Payable and Accrued Expenses

Existence - Accounts payable and accrued expenses are valid liabilities. Rights and Obligations - Accounts payable and accrued expenses are obligations of the entity. *Completeness* - All accounts payable and accrued expenses have been recorded. Valuation and Allocation - Accounts payable and accrued expenses are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded. Greater risk for liabilities is Completeness. This makes testing difference than what we have previously done. With Accounts Payable, what the client tells us is not really what we need to test (We don't go from the balance to the source documents), what we need to test is what is the liability and how can there be an indication of a liability they didn't record (similar to the outstanding check list, we looked at source documents to check the completeness of the outstanding checks list). We will do a Search for Unrecorded Liability, look at source documents that can depict a liability that may not be recorded.

Auditing Property, Plant, and Equipment

General Approach: (1) Small number of transactions (Relatively high dollar transactions); (2) Authorization of Transactions (Board of Directors or approved capital budget) takes on added importance; (3) Less concern for access to assets; (4) More concerned with unrecorded disposals; (5) Agree balances to prior year documentation; (6) Purchases of Property, Plant, and Equipment (Vouch to invoice or cost records. Inspect title. Vouch to board minutes); (7) Expenditures subsequent to acquisition (Vouch to invoice and work descriptions. Consider propriety of classification (expense or capitalize)); (8) Disposal of Property, Plant, and Equipment (Vouch from Property, Plant, and Equipment board minutes. Vouch to cash receipts journal and validated deposit slip. Recalculate gain/loss. Trace from board minutes to Property, Plant, and Equipment for disposals (completeness)); (9) Look for unrecorded disposals (Agree balances to prior year workpapers. Examine insurance policies, property tax records, etc. Physically inspect or confirm fixed assets [Both existing and newly-acquired items. Confirm assets leased to others under capital leases]); (10) Depreciation Expense (Recalculate using useful life, salvage value, cost, and method. Evaluate reasonableness of useful life, salvage value, etc. Is depreciation consistent with company policy (half year conventions)?; (11) Lease Agreements (Verify proper treatment [capitalized or operating]. Ensure disclosure in footnotes is appropriate)

Affect on Audit Report Date by Subsequent Event

Happens After the Audit Report Date (Sufficient Evidence) and Audit Report Release Date. Two Options: Extend Audit Report Date to the Date of this Event (You are then liable for all data up to that point); Or you can Dual-Date (You Keep the Original Audit Report Date but also include the date of the subsequent event and claim responsibility for information referred to this specific event)

Type I - Adjustment; Type II - Disclosure (Possibly Pro Forma Statements)

How are the types of subsequent events treated?

(1) Inquiry, (2) Minutes, (3) Interim Financial Statements (Quarter Financial Statements), (4) Legal Letters

How do auditors become aware of subsequent events?

Unqualified/Unmodified Opinion ("Clean" Opinion, "Present Fairly")

In our opinion, the financial reports are presented fairly without detection of material misstatements.

Fraud in Accounts Payable

If the review for fraud risk indicates that a potential significant risk of fraud exists in the acquisition and expenditure cycle, auditors can use several types of searches and matches using CAATs: (1) Inspect invoices in files for photocopies; (2) Inspect vendor's invoices submitted in numerical order; (3) Inspect vendor's invoices that are always in round numbers; (4) Scan vendor's invoices for invoices that are always slightly lower than a review threshold; (5) Scan vendor invoices for vendors with only post office box addresses; (6) Scan vendor invoices for invoices with no listed telephone number; (7) Match vendor and employee address and telephone numbers; (8) Scan multiple vendors at the same address and telephone number; (9) Vouch a sample of vendor invoices to the approved vendor list; (10) Review invoices for addresses of the local mail drops.

Indicators of Going Concern

If they are not able to continue, this leads to a different presentation of the financial statements since they usually depict that the client will be continuing business (Prepared under the assumption the company will be able to continue). We need to address these going concerns, notify users of the audit reports [Additional paragraph on audit report].

Inherent Risks

Improper Revenue Recognition (Cut-Off, Bill and Hold, Channel Stuffing), Returns and Allowances, and Collectability of Receivables. "•In our initial risk assessment (of IR and CR), IR is what can go wrong, the possible misstatements that could happen. In the revenue and collection cycle, our biggest risk is improper revenue recognition, particularly on the overstatement of revenue by recognizing fictitious transactions or not proper cutoff."

Manufacturing Client

Includes the inventory of Raw Materials (More Similar to Retail since we purchase this), Work-In Process (Difficult to Determine the Value), and Finished Goods (Includes Direct [Materials and Labor] and Indirect [Overhead] Costs vs. Market Price). Assertions? VALUATION becomes the most important assertion for inventory. We would have a lot of recalculations of the valuation, such as looking at the overhead, how indirect costs are distributed to the valuations, etc.

Contents of Written Representations

Information related to financial statements: (1) Management's responsibility for F/S and internal control over financial reporting; (2) Appropriate disclosure, presentation, and reasonableness of items; (3) Statement that uncorrected misstatements are immaterial. Information provided to auditors by management. Internal control over financial reporting (for public entities).

Procedures to Identify Contingent Liabilties

Inquiry (Not Reliable, But is a Good Starting Point); Legal Letters or Attorney Letters (We send manager declared litigation to attorneys to ask if the list is complete); We can look at agreements with their sales (types of contracts and warranties); Historical issues involving warranties

Procedures for Litigation, Claims, and Assessments

Inquiry of clients (Audit Standards: We Cannot Rely on Inquiry Alone, but it is still an extremely useful tool [A Starting Point]). 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 (Litigation especially uses this to determine likelihood of occurring; Primary Evidence of Litigation).

Uncollectible Accounts

Inspect customer files for collectability. Recalculate allowance and bad debt expense. Verify reasonableness of allowance and bad debt expense. Inspect documentation for appropriateness of accounts written off (Inspect documentation for additional collection procedures. Inspect documentation for appropriate authorization).

Components of the Standard Unmodified Report

Introductory paragraph (F/S and years examined). Management's Responsibility section: (1) Management responsible for financial statements; (2) Management responsible for internal control. Auditor's Responsibility section: (1) Auditor responsible for issuing opinion on financial statements; (2) Audit conducted in accordance with GAAS; (3) Audit provides reasonable assurance. Opinion (Are F/S presented in accordance with applicable financial reporting framework (GAAP)?)

Test of Details for Inventory

Inventory Counts; Observations; Existence/Completeness Depends on Direction: Sheet to Floor (What is listed, then we go count) Tests Existence, Floor to Sheet (We count and then look to see if it is recorded) Tests Completeness; Make a Comparison of Cost and Market Value (Price Testing) [Technology has a lot of issues with this]

Substantive Testing, Existence, Completeness (Fill-In)

Inventory Exists? You could count the inventory, which would be an "inspection of physical assets". The auditor would go through and count the inventory. THIS ACTUALLY ADDRESSES BOTH EXISTENCE AND COMPLETENESS. You would select a sample of the inventory to check to see if the amount is recorded correctly (Normally a Haphazard Selection of which items to test).

Lower of Cost or Market

Inventory is recorded at...

Potential Misstatements for Inventory

Inventory that Doesn't Exist, Inventory We Have that is Not Included, Damaged/Obsolete Goods, Valued at Lower of Cost or Market, Does the Client Own the Inventory (Consigned Inventory)

Departure from GAAP

Involves not following the standards of GAAP, or a Misstatement (basically what we are trying to look for, due to error or fraud they do not have stated what we think should be stated. We have to evaluate whether or not the departure is material through quantitative and qualitative methods; we then propose adjustments. If the departure is not material, We can still issue an Unqualified Opinion even though there is still an immaterial departure from GAAP. Is the Departure Pervasive?: Basically means it is wide-spread amongst multiple accounts. If there are multiple aspects of the financial statements being affected by it, OR if the one account is just such a large portion of the financial statements is affected by this departure, it is pervasive. If it is not pervasive, we can give a qualified opinion. "Except for this departure, the financial statements are presented fairly. If it is pervasive, we have to give an Adverse Opinion. "Not presented fairly".

Unqualified Opinion (Standard Report) (Departures from GAAP)

Is the Departure from GAAP Material? "No". Is the Departure from GAAP pervasive? "No"

Qualified Opinion (Departures from GAAP)

Is the Departure from GAAP Material? "Yes". Is the Departure from GAAP pervasive? "No"

Adverse Opinion (Departures from GAAP)

Is the Departure from GAAP Material? "Yes". Is the Departure from GAAP pervasive? "Yes"

Unqualified Opinion (Standard Report) (Scope Limitations)

Is the Scope Limitation Material? "No".

Adverse Opinion

Issued when F/S do not present fairly according to GAAP (i.e., a serious, pervasive departure from GAAP). Report Modifications: (1) Add paragraph preceding the opinion paragraph explaining the departure and detailing $ amounts involved; (2) Change opinion paragraph ("financial statements do not present fairly")

Qualified Opinion

Issued when departure is material, yet not pervasive. Report Modifications: (1) Add paragraph preceding the opinion paragraph explaining departure and detailing $ amounts involved; (2) Modify opinion paragraph ("In our opinion, except for the matter discussed in the preceding paragraph,...."). Opinion Paragraph is Now At the Beginning, so it would not be a preceding paragraph, it would be the first paragraph and described in the following paragraph (Additional Paragraph).

(Scope Limitation:) Qualified Opinion

Issued when scope limitations are material, but not pervasive. Report Modifications: (1) Add paragraph preceding the opinion paragraph describing the scope limitation; (2) Modify opinion paragraph ("In our opinion, except for")

Qualified Opinion ("Except For")

Its presented fairly except for a particular item/specific incident. Every aspect looks good except one specific part.

(1) Separation of Duties, (2) Authorization of Transactions (Write-Offs, EDI Transactions, Credit Checks Prior to Approval of Sale, Pricing), (3) Access to Assets (Shipping Department, Lock Box Account), (4) Adequate Documents and Records (Pre-Numbered Sales Orders, Shipping Documents [Bill of Lading], Sales Invoices, Remittance Advice), (5) Independent Checks on Performance (A/R Subsidiary Ledger to General Ledger, Monthly Statement to Customer)

Key Control Procedures of the Revenue and Collection Cycle

(During the Year Under Audit:) Interim

Lots of required testing can be done. (Risk Assessment, Test of Controls, Substantive Procedures [Detection Risk determines if we do testing more in the interim or at year-end])

Conclusion (For Auditing the Purchasing Process)

Main focus is the search for unrecorded liabilities, which will make sense with the Case Study. It involves a kind of scope, you look at things over a particular dollar amount (brings to the forefront the materiality of these amounts).

Controls to Help Prevent Misstatement of Revenue

Matching Supporting Documents (Make Sure Purchase Order is Matched with Shipping Documents is Matched with Invoice before recording revenue), Segregation of Duties

Component Auditors

May be engaged by group auditors to audit divisions, subsidiaries, or components.

Inherent Risk Assessment (Purchasing Process)

Misstatement Detected in Prior Audits: Generally, the purchasing process is not difficult to audit and does not present contentious accounting issues. However, the auditor's experience in past audits must be considered when assessing inherent risk. Typically, inherent risk is fairly low unless there are indications of misstatements in prior years.

Selected Procedures

Modifying current requirements for attestation engagements related to agreed-upon procedures by: (1) Not requiring specified parties to establish procedures or agree to the sufficiency of the procedures, (2) Not requiring the practitioner to obtain an assertion or disclose an assertion in the report, (3) Not restricting the use of the report

Revenue Recognition

Must be (1) realized or realizable and (2) earned. SEC guidance (SAB 104): (1) Persuasive evidence of an arrangement exists; (2) Delivery has occurred or services have been rendered; (3) The seller's price to the buyer is fixed or determinable; and (4) Collectability is reasonably ensured. "This is a high risk area. We always have to consider the fraud risk. When assessing whether or not this has occurred, we have to know the standard for this. It must be (1) realized or realizable and (2) earned."

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. "FROM THE AUDITOR TO MANAGEMENT. Communication not required by auditing standards, typically it is something the auditor does to give an added benefit to the client. Involves different suggestions from what we saw throughout the audit (not part of the opinion), but it may be beneficial to the client [usually already done verbally]. Ex.) Control Deficiencies = Not required to be communicated, but could help management improve their internal controls. Controls: Controls Around Financial Reporting, Controls Around Efficiency and Effectiveness of Operations, Controls Around Compliance with Laws and Regulations. Risk Assessment Focuses on Financial Reporting Controls, but in Management Letter we can let them know about the other two forms of controls."

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.

Control Activities and Test of Controls (Purchase Transactions)

Occurrence - Observe and evaluate proper segregation of duties. Test a sample of vouchers for the presence of an authorized purchase order and receiving report. Examine paid vouchers and supporting documents for indication of cancellation. Completeness - Review procedures for account for numerical sequence of purchase orders, receiving reports, and vouchers. Trace a sample of receiving reports to their vendors invoices and vouchers. Trace a sample of vouchers to the purchases journal. Authorization - Examine purchase requisitions or purchase orders for proper approval. Review client's competitive bidding process. Accuracy - Recompute the mathematical accuracy of vendor invoice. Agree information in the sample of vouchers for product, quantity, and price. Examine reconciliation of vouchers to daily accounts payable report. Cutoff - Compare the dates on receiving reports with the dates on the relevant vouchers. Compare the dates of vouchers with the dates they were recorded in the purchases journal. Classification - Review purchases journal and general ledger for reasonableness. Examine a sample of vouchers for proper classification.

Audit Report Release Date

On the Audit Timeline, In current days, this has mostly disappeared due to technology (still may be in private companies) but if there is a later release date, take into consideration things that may have happened or changed (subsequently discovered facts)

Non-F/S Information

Other Information Accompanying F/S: (1) Auditors required to ensure information consistent with F/S; (2) If not consistent, either revise opinion on F/S or add emphasis-of-matter paragraph. Required Supplementary Information: (1) Auditors required to perform limited procedures and expand report on F/S to address; (2) Add other-matter paragraph to identify information, describe procedures performed, and identify any issues.

Subsequent Events

Our Audit Procedures will be done around trying to identify subsequent events that happened (after end of year); Close to when we consider that we have enough evidence, we began to look at these subsequent events. From a Financial Accounting Standpoint, with a subsequent event, we still have the three options of Doing Nothing, Disclosing, or Recording/Adjusting. Threshold which before met we do not have to anything involves Materiality. IF IT IS NOT MATERIAL, we do not have to do anything. IF IT IS MATERIAL, you then have to look at TIMING, IF THE CONDITIONS EXISTED AS OF YEAR END, you have to record/adjust, IF THE CONDITIONS EXISTED AFTER YEAR END, you would have to disclose. Example of Disclosure could be Natural Disaster that happened after year-end but leads to material financial issues. You would disclose this. Example of Record/Adjust: Our client has a large customer with a big A/R balance, sometime in January the customer files for bankruptcy. Whether or not it is indicative of conditions that existed as of year-end IT DEPENDS on if you can see conditions early on that the customer was not doing well, deteriorating, and was imminent to file bankruptcy THIS WOULD BE CONSIDERED INFORMATION FROM BEFORE YEAR-END AND WE SHOULD RECORD IT; however, there are other reasons outside of what was present such as an after year-end lawsuit or a natural disaster THIS CONDITION IS NOT PRESENT AT YEAR-END SO YOU WOULD DISCLOSE. If something happens between Audit Report Date and Audit Report Release Date, we can MOVE THE AUDIT REPORT DATE TO AUDIT REPORT RELEASE DATE (which opens us up to responsibility for all events up that point in time; if something happens you can adjust the report but you are on the hook for all information up to that date), or YOU CAN DECIDE TO DUAL-DATE (Maintain original audit report date, but include a statement that states we accept responsibility for a particular event that happened on this date before the release, we will only then be held responsible for that event). We can also issue a revised opinion and force management to produce revised financial statements.

Omitted Procedures

Perform procedures if: (1) Omitted procedures are important; (2) Individuals are currently relying on financial statements and auditors' reports. If previous opinion can be supported, no further action necessary. If previous opinion cannot be supported: (1) Withdraw the original report; (2) Issue revised reports Inform persons currently relying on the financial statements.

Contingent Liabilities (Preview)

Possible Litigation, Warranties, Tax Disputes. As of year-end, something happened prior to year-end leading us to believe there is a possible liability, but that liability is contingent on future events (possible liability).

Prepaid Expenses

Prepaid Rent, Prepaid Insurance, etc. If you have a prepaid, this is an asset account, so we are concerned with the Existence, you could use a confirmation (especially if it is high-risk) or you could look at the documents involved to see if the invoice has been paid (proof of payment shows the existence of the prepaid). You could also do a quick recalculation to ensure that the prepaid is at the right amount at year-end.

Using Confirmations

Primarily for verifying existence. Factors likely to affect the reliability of these: (1) Previous audit experience, (2) Intended recipient of the confirmation, (3) Type of information being confirmed (Auditor may confirm entire balances or individual transactions), (4) Type of confirmation being sent

Types of Subsequent Events

Provide new information about conditions existing at date of the financial statements (Adjust financial statements to reflect new information). Involve events that arose following the date of the financial statements (Disclose in financial statements).

Written Representations

Provided by management to auditors. Dated using date of auditors' reports (audit completion date). Broad purpose: (1) Impress upon management its primary responsibility for the financial statements; (2) May establish auditors' defense if a question related to inquiries subsequently arises; (3) Qualify or disclaim an opinion if not provided by the client.

Communication with Individuals Charged with Governance

Public Companies: Charged with Governance = Audit Committee/Board of Directors as a Whole. We (the audit team) are required to communicate in writing any significant deficiencies (moderate internal controls deficiencies) and material weaknesses (Most Severe Internal Controls deficiencies). (Not Control Deficiencies, which are the lowest level of internal controls deficiency). Material weaknesses also must be told to the public with an adverse opinion (unless issues are fixed early on with enough time to retest).' Letter to those charged w/ governance. Only aspect that has to be in writing, BUT other communications would be included due to convenience. For Public Companies: This letter to individuals charged with governance needs to be before Audit Report Release Date. For Private Companies: This letter is typically provided before Audit Report Release Date as well, but they are REQUIRED to do so 60 day after this date.

Use of the Work of Specialists

Reconciles differences between requirements for use of an auditor-employed specialist (AS 2501) and auditor or company-engaged specialist (AS 2510). Requires the auditor to evaluate the methods and significant assumptions of a company's specialist when the auditor uses that work as audit evidence. Provides specific requirements for evaluating the work of a company's specialist, including assessing competence and objectivity, and testing and evaluating the work of the specialist. Different from ISA 620: Continues to employ separate standards for use of auditor-employed and auditor-engaged specialists, primary differences in requirements to evaluate objectivity of engaged specialists.

Cut-Off (Revenue; Inherent Risks)

Recording revenue before year end when it occurred after.

Auditing Accounting Estimates

Replaces AS 2501, 2502, and 2503 with a single standard. Establishes an objective that accounting estimates should be free from management bias that cause material misstatements. Requires a discussion among the key engagement team members of how the financial statements could be manipulated through management bias. Explicitly require the auditor, when developing an independent expectation of an accounting estimate, to have a reasonable basis for the assumptions he or she uses. Establishes a requirement for the auditor to understand management's analysis of critical accounting estimates in evaluating the reasonableness of significant assumptions and potential for management bias. Extends many requirements for fair value estimates to all accounting estimates. Establishes requirements for how to determine whether pricing information obtained from third party pricing sources, including pricing services and brokers or dealers, provides sufficient appropriate audit evidence.

Other Information Included with the Financial Statements in Annual Reports

Requires explicit reporting on other information included with the financial statements in annual reports, including: (1) Management's responsibility regarding other information, (2) Auditor's responsibility for evaluating and reporting on other information, (3) Statement regarding material misstatement (if any) in other information.

Auditors (Role of Various Parties in Audit of Litigation, Claims, and Assessments)

Responsibilities: (1) Inquire of client regarding the existence of litigation, claims, and assessments; (2) Perform various procedures regarding litigation, claims, and assessments; (3) Initiate request to the client for attorney letter; (4) Mail Attorney Letter Prepared by Client.

Client (Role of Various Parties in Audit of Litigation, Claims, and Assessments)

Responsibilities: (1) Respond to auditors' inquiries regarding litigation, claims, and assessments; (2) Provide auditors a list, description, and evaluation of litigation claims, and assessments; (3) Prepare letter to attorney (attorney letter) that includes information related to litigation, claims, and assessments.

Inventory Focused Clients

Retail Clients (Sell Inventory to Customers), Wholesale Clients (Sell to Retailers), or Manufacturing Client (Raw Materials) = These different clients have different risks.

Revisions to SSAE No. 18

Revises SSAE No. 18 as follows: (1) Examination and review engagements: - Requires written representations regarding the subject matter's measurement and evaluation against criteria, (2) Review engagements: - Changes the term "review" to "limited assurance" - Requires report to include description of the work performed in these engagements, (3) Agreed-upon procedures engagements: - No longer requires all parties to the engagement to agree to procedures in agreed-upon procedures engagements - Permits a general use report for agreed upon procedures engagement if certain criteria are met.

Search for Unrecorded Liabilities (SURL) (Review)

Searching for liabilities that have not been recorded. SUBSEQUENT DISBURSEMENTS (WHAT DID THEY PAY AFTER YEAR-END); UNPAID (OPEN) INVOICES [A/P IN JANUARY THAT RELATED TO LAST YEAR]; UNMATCHED RECEIVING REPORTS (PURCHASE ORDERS: WE ORDERED AND RECEIVED IT BEFORE YEAR-END, SO IT SHOULD HAVE A LIABILITY).

Audit Reporting

Significantly revises form and content of auditor's report, including disclosure of critical audit matters. Revises form and content of auditor's report (similar to new standard approved by SEC for issuers under PCAOB standards). Moves the "Opinion" section and "Basis for Opinion" section to the beginning of the report. Includes a statement regarding the auditor's independence and fulfillment of other ethical responsibilities in the "Basis for Opinion" section. Requires auditor to communicate key audit matters (similar to critical audit matters) if terms of the engagement include reporting key audit matters (unlike issuers, communication of KAMs is not required for audits of non-issuers). Requires auditor to report on other information included with the financial statements in annual reports (see related exposure draft). Expands the description of responsibilities of management and auditors.

Circumstance-Imposed (Scope Limitation)

Situation in which matters beyond auditors' and client's control limit procedures performed by auditors. Example: inability to observe year-end inventory because of late appointment. It is not because of the client, but a situation that does not allow us to collect the evidence that we would. Ex.) We are hired after year-end, so we cannot perform a year-end inventory count. Another Ex.) Electrical storms fry your digital records.

Aged Trial Balance of Accounts Receivable (Valuation is also a high-risk area)

Some of the procedures discussed for existence of A/R (such as confirmations) can also be used to determine correct valuation. Big part of valuation is that it is a net value (gross amount). A/R less allowance for doubtful accounts (you have to ensure the Allowance account is accurate). A big part of this is an aged trial balance of accounts receivable: (1) Categorized as within 30 days, 30-60 days, 60-90 days, and 90 days. (2) We have to ensure these balances are in the correct aging buckets because the older the item is the less likely the client will be able to receive payment for it. (3) Testing these aged balances would involve looking at the supporting documents (invoices). Difference between invoice date and Dec. 31 would be the age of the A/R. (4) Based on these ages, what is a reliable allowance for doubtful accounts. (5) Analytical Procedures: These are helpful for testing the balance of the A/R and the Allowance for doubtful accounts (use usual ratios for these amounts, maybe compare them to sales). (6) Test of Details: Looking at separate accounts to see if they are timed (aged) correctly.

Subsequent Events (Preview)

Something Occurs After Year-End (Presence Not Detectable at Year-End). If Material, a Disclosure needs to be made. Event happens after year-end, but it sheds light on a condition that already existed after year-end. Adjustments in recording that amount may be made instead of just a disclosure. Ex.) Customer of Client Filing for Bankruptcy. If it leads to an adjustment (recording), usually involves an estimate with a subsequent event giving more knowledge of the previous estimate.

Confirmations, Test of Details (Fill-In)

Standards Require us to use __________________ as a ________ ____ ____________ for Accounts Receivable UNLESS: (1) A/R is not material to the financial statements (Ex. Hotel, would most likely not allow you to stay and then pay at a later date), (2) If the Risk of Material Misstatement is Low (And we have done other procedures that were more efficient to help establish a higher detection risk), (3) Confirmation is Expected to Be Ineffective (This is difficult to convince, you would have to thoroughly document this. A confirmation may be ineffective if there is an extremely low response rate from the client's customers; last year you sent over a 1000 confirmations, received 2 back. Or if there was a high error rate, out of the 1000 sent, 400 of them were wrong).

(1) Develop an Expectation, (2) Define Tolerable Difference (Based on Policy), (3) Compare Actual (Given) to Expected, (4) State Whether Actual is Greater than or Less than Our Expected

Steps for Analytical Procedures

Analytical Procedures (Completing the Audit)

Study of relationships among financial and non-financial data: (1) Can be used in planning (required), substantive testing, and near the end of the audit (required), (2) Near the end of the audit, analytical procedures identify unusual or unexpected relationships not previously identified. Review accounts for "miscellaneous," "other," and "clearing" accounts (may relate to earnings management).

Changed Form

The PCAOB has made MAJOR CHANGES recently: (1) Release 2017-01 (Docket 034) included in AS3101 Changed form of report, includes "CAM", and tenure; (2) Form AP-Identify Engagement Partner and Other Firms. "Changed Form: The Audit Opinion had been the same for all practical purposes since 1930s until, 2002 and the SOX act. Additional paragraph relating to the opinion on internal controls. Proposed in 2013, but does not come into affect until 2019 and companies other than the largest of the large are required to change in 2020. New Standard Changed the Form of "Intro, Scope, Opinion" to "Opinion, Basis for Opinion, Critical Audit Matters". Critical Audit Matters: Previously they would either pass or fail (unqualified or adverse [other than additional information in the unqualified opinion, but they were not common]). This allows for more description of potential issues. An auditor tenure is included after the signature (We have served as this client's auditor since XXXX). This can either be seen as knowing the client better leads to a more quality opinion, or this could be seen as a potential for some collusion between the auditors and client. Significant Change in Wording: Responsibility is due to detect material misstatements due to error or fraud.

Tests of Details of Transactions, Account Balances, and Disclosures: Cutoff

The auditor attempts to determine if all purchase transactions are recorded in the proper period. On most audits, the purchase cutoff is coordinated with the entity's physical inventory count. Proper cutoff should also be determined for purchase return transactions. This typically takes place with other cutoff tests. Looking at last shipments in and out for the last year, and the first shipments in and out at the beginning of the next year to ensure they have occurred and are complete.

Matters Related to Confirmations

There are three sets of circumstances that could justify the omission of the confirmation of a client's accounts receivable: (1) Not material to the financial statements, (2) If the risk of material misstatement is low (the assessed level of evidence from analytical procedures and other tests of details is sufficient to reduce audit risk to an acceptably low level; confirmation of accounts receivable may be inefficient), (3) Confirmation of accounts receivable is expected to be ineffective (based on previous years' audit experience)

Contingent Liabilities

These can be grouped together as Contingent Liabilities, a liability that is contingent upon future events. Litigation, Claims, and Assessments: Possible Litigation is the first thing we look at. Warranties and guarantees are the second thing we look at (Especially manufacturing clients): These lead to the possibility of claims against the warranties on the items sold. Probability of the claim occurring and what the costs might be. Tax Disputes are another thing to keep on the radar: Uncertain tax positions, taxes audited. With all of these we are thinking through what is the likelihood of their being a type of payment or settlement and can we estimate the amount. Is it Estimatable? Yes or No. Is is Likely? Remote, Reasonably Possible, Probable.

A/R and Sales

These can be higher risk areas, so you may be responsible for parts of that, such as the confirmation processes.

Proposed Statements on Auditing Standards

This Summer, the AICPA sent out proposed statements on auditing standards (proposed changes to their standards). Ex.) Auditors began using drones on their audits in agricultural settings, but now they are also being used in inventory counts. Some of the wording around the standards of inventory counts needing to be done by an audit personnel, so can they have the drone pilot do the count? The general consensus is that we do not need to address every technique or technology, but just have a more generalized wording of the standards to conform to the principles but be able to use technology with enough professional skepticism. Example of Technology is ADA (Audit Data Analytics), which is used to process a lot of data for the audit. They also talked about artificial intelligence. Another technology is robotic process automation (RPA), which is one of the biggest transforming technologies being implemented right now. RPA: When you use excels you may use macros, which allow you to automate processes based on some kind of logic. RPA are basically like excel macros that are not bound by a single application. This macro can complete processes across everything on your computer. Can complete data manipulation, send mass emails to customers, and other audit tasks. Another example of technology is Blockchain, which is tied to crypto currency. This is a distributed ledger that allows many people to contribute but also confirm information within it. Not really impacting accounting yet, used more in operations such as the food industry.

Timing of Procedures

This is Important, so if Inventory is High-Risk, you most likely need to go out and count the inventory on Year-End (So since this is usually December 31 this is a job given to interns and new staff).

Group Audit Aspect

This is more of still filling an Unqualified Opinion, but modifying the opinion by changing the wording. So you would still say "In our opinion, the financial statements present fairly" Later it would just say, "Here is information we think is still important.

Management Representation Letter

This we typically refer to as the "this", correspondence that is addressed to the auditors from management of the client. Beyond just accepting responsibility for the financial statements, there are statements in there surrounding acceptance for responsibility of financial statements, internal controls, appropriate disclosure, and uncorrected misstatements are immaterial; If there is anything else that management has stated to us or assured us of, we may want those things included in this letter to better protect us as auditors; to qualify or disclaim an opinion if not provided by client, if they do not provide this letter this is a Scope Limitation, which is such a big red flag that it could lead to an automatic qualified opinion or disclaim of the opinion. We want this as of the Audit Report Date.

Form AP Change

This which is able to be found online, now Includes the Name of the Engagement Partner and the Other Firms Involved in the Audit (Sometimes would affiliate with staff of other firms). Originally on the Audit Report, it was just the firms name, now it includes this other information.

Critical Audit Matters

Those matters communicated or required to be communicated to the audit committee that (1) relate to accounts or disclosures material to the financial statements and (2) involve challenging, subjective, or complex auditor judgment. These disclosures are similar to those mandated by International Standards on Auditing 7013 (referred to as key audit matters). The introductory vignette in Chapter 12 illustrates some of the key audit matters identified in KPMG's audit of Rolls-Royce. For each critical audit matter identified, the auditor's report should: Describe the considerations that led the auditor to identify the critical audit matter. Describe how the critical audit matter was addressed in the audit. Refer to the relevant financial statement accounts or disclosures that relate to the critical audit matter.

Completeness (Fill-In)

To test _________________________, you have to have a control that detects what isn't recorded (Such as looking at a numerical sequence to see if there are missing documents).

Sales Cutoff Procedures

Used to verify whether Sales/Revenues recorded in the correct accounting period (Holding the books open). Examine sales invoices and shipping documents shortly prior to and after year-end. Examine returns after year-end.

Audit Risk, Risk of Material Misstatement, Detection Risk (Fill-In)

Using the Audit Risk Model: (1.) Set ___________ _________ at desired levels (normally, low). (2.) Assess ______ ____ ___________ ______________, which incorporates inherent risk based on the nature of the account balance or class of significant transactions and control risk based on gaining an understanding of internal control. Note that AS 2110 indicates that the auditor should [presume that there is a fraud risk involving improper revenue recognition. (3.) Set _______________ _________ at the significant account and assertion level based on the level of audit risk and risk of material misstatement.

Uncorrected Misstatements

Usually just a list of adjusting journal entries to fix all misstatements. Not required to communicate immaterial, corrected misstatements (But usually just include an entire schedule of misstatements). If we find a material misstatement, there has to be a good reason not to have a material weakness. (Material Weakness means controls are working in a way that is not likely to detect material misstatement, so if there is a material misstatement without a material weakness that is hard for the auditors to argue).

Subsequent Events After Issuance of Financial Statements

We are responsible for notifying all parties that rely on these financial statements (Banks, Owners, SEC, etc.). Determine if there is a misstatement, have client restate the financial statement (8-K that notifies the SEC).

Scope Limitations (Preview)

We don't have access to evidence that we would collect under ordinary conditions (that we would collect otherwise). This scope limitation can relate to a lot of different things.

Goods are Not Received

We get a response back and the client says the "____________ _______ _______ __________" Possible Misstatement? Could be, or it could be a timing issue; It depends. If goods were not received by Dec. 31, being able to confirm revenue is based on when the goods were shipped. If the goods were shipped on Dec. 30 FOB Shipping Point, it may still be considered revenue. To be able to determine when the revenue should be recorded, you should look at the shipping documents, such as a Bill of Lading. (When it was shipped, what was shipped, shipping terms).

Amount is Incorrect

We get a response that says "____________ ____ ___________________". Maybe the amount is in dispute (took advantage of discount not shown), amount shipped is not right (we charged more), it could be anything, so we have to start digging. We can look at any of the documents above, shipping documents, purchase order, sub-ledger, etc. We need to make sure the transactions included in the A/R are correct.

Goods Were Returned

We get a response that says "____________ __________ ______________". You could look at the sub-ledger to see if a credit memo was created or sent to the right customer. You could look at the receiving reports to see when the returned goods were received at the company, before or after year-end.

Already Paid

We get a response that says we "______________ _________". Possible Misstatement? If the payment was received and cash increased but A/R did not go down, this could be a misstatement. Or it could be just a timing difference (the confirmation doesn't get to them until after they paid after year-end). Or they could have sent the check before year-end, but the company did not receive check until after year-end. You could look at the A/R sub-ledger to see if there were entries made in January that indicate payment. Look at the bank statement to see when the check is deposited. We can look at credit memos to see whether or not the payments may have been credited to another customer.

Final Analytical Procedures

We have final analytical procedures that are required under auditing standards. Geared towards final audited balances, nothing appears out of line with expectations.

Occurrence, Completeness, Cutoff, Valuation (& Allocation), Existence (& Occurrence), Completeness

What Management Assertions are we concerned with it for Revenue Inherent Risk? Improper Revenue Recognition = _________________, ___________________ (Difficulty of the process may lead to them recognizing revenue too late; or there could also be incentives to understate revenue such as if you have already met all financial expectations, I may want to hold some back for next year to give us a head start next year), _____________ as well (Not a PCAOB, kind of split between Occ. And Complete., but is still important); Accounts Receivable = ________________ (collectability of it), __________________, maybe some _____________________ if there were completeness issues with Revenue.

Subsequent discovery of fact - determine restatement, notify all parties

What about events after the issuance of financial statements?

(1) Industry Factors, Complex Revenue Recognition, (2) Difficulty Auditing (Size, Type of Transaction, Evidence Available), (3) Prior Misstatements

What affects inherent risks of revenue?

(1) Warranties, (2) Litigation, (3) Tax Disputes

What are some common examples of Contingent Liabilities?

(We would go to management to see if they can alleviate) (1) New financing, (2) Refinancing (delay or reduce payment), (3) Sale of assets or business segment

What are some mitigating factors of going concerns?

Primary: Existence/Occurrence, Valuation Secondary: Rights and Obligations, (Maybe Completeness)

What are the key assertions for A/R (Primary and Secondary)?

Primary: Existence, Valuation Secondary: Completeness, Rights and Obligations

What are the key assertions for Inventory (Primary and Secondary)?

Primary: Existence/Occurrence, Valuation and Allocation Secondary: Completeness (Existence/Occurrence and Completeness make up Cutoff)

What are the key assertions for Revenue (Primary and Secondary)?

Completeness

What are the key assertions of A/P?

(1) Evidence of Arrangement, (2) Delivery, (3) Price, (4) Expect to Collect

What are the requirements for revenue to be recognized?

(1) Segregation of Duties, (2) Matching of Supporting Documents, (3) Authorized Price Listing (Fixed and Determinable Prices)

What controls may prevent misstatements of revenue?

Conditions/Ratios (Recurring losses, negative cash flows, low current ratios, high leverage); Other Factors (Loan default, work stoppage, litigation)

What could indicate substantial doubt about going concern?

(1) Uncollectible account from financial deterioration of customer (not sudden event); (2) Settlement of a Lawsuit

What is an example of Type I Subsequent Events?

(1) Casualty (Natural Disaster); (2) Merger & Acquisition(, Segment Disposal, etc.)

What is an example of Type II Subsequent Events?

(1) Subsequent Disbursements, (2) Unpaid (Open) Invoices, (3) Unmatched Receiving Reports

What is our sample for finding unrecorded liabilities?

Type I condition existed at balance sheet date but became aware afterwards. Type II condition arose after the balance sheet date.

What is the difference between Type I and Type II Subsequent Events?

After year-end but before issuance of financial statements (After Year-End, Before Release of Audit Report)

What is the time window for "subsequent events"?

(1) Inquiry (need to corroborate), (2) Legal Letters, (3) Minutes (Board of Director Meetings), (4) Contracts, Representation Letter

What procedures identify contingent liabilities or provide reliable evidence?

(1) Inventory Counts, (2) Observations, (3) Sheet to Floor, Floor to Sheet, (4) Comparison of Cost and Market Value

What test of details do we perform for Inventory?

Search for Unrecorded Liabilities (SURL)

What test of details do we perform with A/P?

(Typically perform) Disbursement Testing (as test of controls/dual test)

What tests of controls are used for Expenses?

(1) Confirmations, (2) Look at Subsequent Cash Receipts, (3) Look at Supporting Documents, (4) Come Up with Our Own Independent Allowance Estimate, (5) Observe Board Minutes

What tests of details do we perform for A/R?

Dr. Accounts Receivable, Cr. Sales Revenue, Dr. Cost of Goods Sold Cr. Inventory (Revenue); Dr. Cash Cr. Accounts Receivable, Dr. Bad Debt Expense, Cr. Allowed for Doubtful Accounts (A/R)

What transactions that are actually happening? "1.) Order of Goods, doesn't initiate anything than the process; 2.) We ship goods, (*Journal Entries*); 3.) bill customer, no journal; 4.) We receive payment, (*Journal Entries*)".

(1) Inventory recorded does not exist, (2) impaired value, (3) incorrect cost allocation, (4) failure to record inventory, (5) inventory on consignment

What type of misstatements might occur for Inventory?

(1) Fictitious Customer/Balance, (2) Inadequate Allowance, (3) Factored Receivables

What types of misstatements might occur for A/R?

Failure to Record Liability

What types of misstatements might occur with A/P?

(1) Fictitious Customer/Sales, (2) Incorrect Period, (3) Incorrect Amount

What types of misstatements might occur with Revenue Risks?

(1) Engagement Letter (To Client [Management] from Auditors), (2) Management Representation Letter(From Management to Auditors), (3) Significant Deficiencies and Material Weaknesses (To Audit Committees, Management, and Board of Directors from Auditors), (4) Management Letter (From Auditors to Management)

What types of written communication are made during the audit?

Valuation (Inventory)

You could rely on price testing, such as an analysis like a recalculation to make sure the math of the quantity times the price is correct. But really, we are worried about the lower of cost or market. We would look at invoices of the most recent purchase made to see the market price. We would then consider FIFO or LIFO method to determine what the historical cost of the inventory is. Then we check to see if the price used is the lower of the market or cost.

May Issue Disclaimer (Fill-In)

______ ________ ___________ if: Lack of independence; Associated with financial statements; Material and pervasive going-concern uncertainty.

Negative, Positive (Fill-In)

_____________ Confirmation = · Response you get is when the balance is correct. ______________ Confirmation = Response may be the account is correct or there is a misstatement.

Revenue (Fill-In)

_____________ is an area in which the basis of it depends drastically on the industry that we are talking about. The cycle varies for example, a service industry vs. a retailer. The textbook focuses more on the retail setting.