ACCT 5200 Mathews Test 1
Basic Purposes of Analytical Procedures:
-Planning the audit and understanding the client in the context of its industry and business. -Assess the entity's ability to continue as a going concern (financial problems). -Indication of possible misstatements in the F/S. -Reduce detailed audit tests.
SOX-related employment rules:
-1 year cooling off period before hiring former auditor as CEO, CFO, CAO -Prohibited from employing suspended or barred auditors -May not extend loans to directors or corporate officers
operational audit
evaluates the efficiency and effectiveness of any part of an organization's operating procedures and methods; auditors struggle with the subjectivity of it
Name and describe audit objective for classification assertion for B/S items
classification; receivable are properly placed as to accounts receivable and notes receivable
Name and describe audit objective for Classification assertion for transactions
classification; same concept as assertion
privileged information
client information that the professional cannot be legally required to provide; information that an accountant obtains from a client is confidential but not privileged
For prospective clients that have previously been audited by another CPA firm, the new (successor) auditor is required by auditing standards to
communicate with the predecessor auditor to help the successor evaluate whether to accept the engagement. The burden of initiating the communication rests with the successor auditor, but the predecessor auditor is required to respond to the request for information. The client must give permission for the predecessor to share their info due to confidentiality rules.
Phase 4 of audit process
complete the audit and issue the report
Name and describe audit objective for Completeness assertion
completeness; same concept as assertion
Compliance Audit
conducted to determine whether the auditee is following specific procedures, rules, or regulations set by some higher authority Examples: - Determine whether accounting personnel are following the procedures prescribed by the company controller. - Review wage rates for compliance with minimum wage laws.
financial statement audit
conducted to determine whether the financial statements (the information being verified) are stated in accordance with specified criteria. Normally, the criteria are U.S. or international accounting standards,
The two required types of audit evidence:
confirmation and analytical procedures
standard unqualified audit report
The 4 conditions have been met: 1. All statements are included in the financial statements 2. Sufficient appropriate evidence collected and audit performed in accordance with auditing standards 3. Financial statements are presented fairly in all material respects in accordance with GAAP or other appropriate accounting framework (includes adequate disclosures). 4. No circumstances requiring emphasis, explanatory paragraph, or modified wording.
Management Participation Threat
The threat that a member will take on the role of an attest client management or otherwise assume management responsibilities, such as may occur during an engagement to provide nonattest services.
Familiarity threat
The threat that, due to a long or close relationship with an attest client, a member will become too sympathetic to the client's interest or too accepting of the client's work or product.
Current files (documentation)
all audit documentation applicable to the current year; audit plan, audit programs, working trial balance, minutes of meetings, adjusting journal entries, reclassification journal entries, current f/s, working papers supporting schedules
Existence (mgmt assertion)
all recorded balance sheet balances are for real assets and liabilities on the B/S date *typically a concern for assets
Substantive Analytical Procedures
an analytical procedure in which the auditor develops an expectation of recorded amounts or ratios to provide evidence supporting an account balance
Key position
an individual at a client who has primary responsibility for: 1. significant accounting functions 2. Prep of F/S 3. Ability to influence prep of F/S (CEO, COO, CFO, President, etc.)
Which of the following is an assurance service? a. Bookkeeping b. Preparation c. Compilation d. Audit
d. Audit
To test management assertions, we
divide financial statements into cycles
SOX requires public companies to report management's assessment of the
effectiveness of internal control. The Act also requires auditors for larger public companies to attest to the effectiveness of internal control over financial reporting.
Accuracy, Valuation, & Allocation (mgmt assertion)
whether recorded balances are included in the financial statements at correct amounts, including appropriate allowances for valuation *EX: · Is the correct price (LCM) used to value inventory?
Cutoff (mgmt assertion)
whether recorded transactions are recorded in the correct accounting period.
Accuracy (mgmt assertion)
whether recorded transactions are stated at the correct amounts *EX: Sale recorded incorrectly because incorrect price used
Classification (mgmt assertion)
whether recorded transactions or balances on F/S are in the appropriate account *EX: So, are repairs and maintenance costs appropriately expensed or are they capitalized?
Two most expensive types of evidence
physical examination and confirmation
Phase 1 of Audit Process
plan and design audit approach based on risk assessment procedures
Analytical Procedures are required during the
planning and completion phase of the audit
Debt to Equity Ratio
total liabilities/total equity
EPS =
(Income-Pref. Divs.)/Shares Outstanding
Gross margin % =
(Rev-COGS) /Rev
To become a CPA, there are 3 requirements
1. educational 2. CPA exam 3. experience
What is evidence?
Any information that auditors can use to make sure statements are made in accordance with GAAP. Different types have varying levels of persuasiveness.
Auditor's Responsibility for Fraud (AS 2401)
Auditors have a responsibility to obtain reasonable assurance that the F/S are free from material misstatements, including material misstatements caused by fraud. 3 Steps: - Consider the presence of fraud risk factors during all stages of the audit process. - Based on the risk factors present, make an assessment of the risk of material misstatement due to fraud. - Based on that assessment, develop an appropriate response.
Name and describe audit objective for Occurrence assertion
Occurrence; same concept as assertion
Audit planning phase 3:
Perform analytical procedures and tests of details of balances
General Corporation
The advantage of a corporation is that shareholders are liable only to the extent of their investment in the corporation. Most CPA firms do not organize as general corporations because they are prohibited by law from doing so in most states.
insurance hypothesis
The assumption that an audit provides "insurance" if something goes wrong. This allows shareholders or politicians to blame auditors whenever companies fail.
Physical Examination Evidence
The inspection or count of a tangible asset by the auditor. Which determinants of persuasiveness are in operation? Auditor's direct knowledge Note: If an object being examined has no inherent value (a sales invoice), the evidence is called documentation.
FASB Concept Stmt 2 defines materiality as
The magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
Management's Responsibility for the Financial Statements
The responsibility for adopting sound accounting policies, maintaining adequate internal control, and making fair representations in the financial statements.
Self interest threat
The threat that a member could benefit, financially or otherwise, from an interest in, or relationship with, an attest client or persons associated with the client.
Persuasiveness of evidence
We cannot be completely convinced. We must be persuaded by two factors: 1. appropriateness 2. sufficiency
reasonable assurance is high, but not _________
absolute
Name and describe audit objective for Accuracy assertion
accuracy; check that correct amounts are used for price, quantity, etc. *also* Posting and summarization; check that transactions are correctly transferred from journals to ledgers
permanent files (or continuing audit files)
contain data of a historical or continuing nature pertinent to the current audit.
Inventory Turnover
cost of goods sold/average inventory
The three least-expensive types of evidence:
observation, inquiries of the client, and recalculation
Times Interest Earned
operating income/interest expense
Direct financial interest
when the auditor owns equity or debt instruments of a client directly
Audit Data Analytics
"Audit data analytics are the science and art of discovering and analyzing patterns, identifying anomalies, and extracting other useful information in data underlying or related to the subject matter of an audit through analysis, modeling, and visualization for purpose of planning or performing the audit."
Form S-1
"S" forms apply to the Securities Act of 1933 and must be completed and registered with the SEC when a company plans to issue new securities to the public. The S-1 form is the general form used when there is no specifically prescribed form. The others are specialized forms. For example, S-11 is for registration of securities of certain real estate companies.
Audits' part in capital markets
"The strength of the U.S. capital markets depends on investors knowing that they can rely on the financial information that is available to them when they make investment decisions."
Independence requires
"independence in fact" and "independence in appearance" (reasonable investor rule)
Audit Objectives related to Management assertions
- Break management assertions into manageable chunks that allow auditors to test the assertions - If auditor has sufficient evidence that audit objective is met, then she also has reasonable assurance F/S's are fairly presented
Exceptions for independence violations:
- Individual did not know the circumstances giving rise to violation - Violation was corrected promptly once the violation became apparent - Firm has quality controls in place that provide reasonable assurance that the firm and its employees maintain independence
Firm, covered persons, and immediate family prohibited from material indirect investments including:
- Owning >5% of entity that owns interest in audit client - Owning >5% of entity of which audit client owns an interest
Standards Setting Organizations for Auditing:
-Auditing Standards Board (ASB) -Financial Accounting Standards Boards (FASB) -Public Company Accounting Oversight Board (PCAOB) -Securities and Exchange Commission (SEC)
5 Types of Analytical Procedures
-Compare client and industry data. -Compare client data with prior-period data. -Compare client data with client-determined expected results. -Compare client data with auditor-determined expected results. -Compare client data with expected results, using non-financial data.
Sarbanes-Oxley Act of 2002 Timeline
-Enron problems came to light October 2001 -Andersen indicted 3-14-02; convicted 6-15-02 -WorldCom fraud exposed 6-27-02 -Congress passed 7-25-02; -Pres. Bush signed 7-30-02
Permanent files include
-Extracts or copies of company documents or other electronic records of continuing importance such as the articles of incorporation, bylaws, bond indentures, and contracts -Analyses from previous years of accounts that have continuing importance to the auditor. -Information related to understanding internal control and assessing control risk -The results of analytical procedures from previous years' audits.
What can we learn from analytical procedures during completion?
-Help assess going concern issues - does the company have any unusual ratios that may indicate an issue that the company could struggle to continue 12 months past the balance sheet date?
What we learn from analytical procedures during planning?
-Help understand changes in the client's business over year -Held identify trends or specific events to consider during planning
AICPA Rules of Conduct
-Integrity and Objectivity -Independence -General Standards (like due care, competence, adequate evidence, etc.) -Compliance with the standards -Accounting principles -Acts Discreditable (be above reproach) -Contingent Fees (no cont. fees for audit clients) -Commission and Referral Fees (no comm. or ref. fees for audit clients) -Advertising and other Solicitation (no false, misleading, or aggressive advertising) -Confidentiality -Form of organization and name (don't mislead)
Requirements for Audit Committees:
-Members must be independent of issuer - this excludes: family and employees of management people with significant business relationships with company some interlocking directors -AC is responsible for oversight of auditor and Must pre-approve all audit and non-audit services -Must receive regular updates from auditor on: 1. Accounting treatments 2. Alternative GAAP treatments and auditor's preference -Accounting disagreements between auditor and management
SOX-related disclosure rules:
-Must disclose equity transactions with management and 10% stockholders within 2 days -Must disclose whether they have adopted code of ethics for senior officers -Must disclose information about "material changes" on real time basis -Must disclose off-balance sheet transactions -Must disclose existence of "financial expert" on audit committee
SOX requirements for Accounting Firms:
-Must register with PCAOB -Must: Comply with PCAOB auditing and professional standards Comply with quality control standards Submit to PCAOB quality control inspections Must retain documents for 7 years 5 year felony imposed for failure to maintain "all audit or review work papers" New: Must comply with internal controls testing standards Must attest to management's representations on internal controls (Sec. 404) Must obtain audit committee pre-approval for services Must be responsible to the audit committee Not new, but now law: Must use a second partner review Must rotate audit partners every 5 years (was 7-year professional requirement)
Inquiries of Client Evidence
-Obtaining written or oral information from the client in response to questions from the auditor -Inquiry cannot be regarded as conclusive because it is not from an independent source and may be biased in the client's favor. It must be further corroborated
SOX created the _____ which must:
-PCAOB -propose rules, adopt interim or transitional auditing rules and professional standards within 270 days (adopted ASB standards for an interim basis)
Professional Skepticism
-Professional Skepticism is an attitude that includes a questioning mind and a critical assessment of the audit evidence. -Since evidence is gathered throughout the audit, professional skepticism should be exercised throughout the audit process.
The codification by the ASB has 4 main sections:
-Purpose of an audit (Purpose) -Personal responsibilities of the auditor (Responsibilities) -Auditor actions in performing the audit (Performance) -Reporting (Reporting)
Recalculation evidence
-Rechecking a sample of the computations -Includes: 1. rechecking arithmetical accuracy (e.g., footing and cross-footing) 2. checking computation of depreciation expense
Reperformance evidence
-Rechecking transfers of information made by the client during the period under audit. -Includes: ¢ transfers of information (e.g., from sales journal to general ledger) ¢ comparing price used on an invoice to the master price list
Capital Acquisition and Repayment cycle
-Relate to financing the business, few transactions but highly material -B/S Accounts: Cash in bank, Notes payable, Long-term notes payable, Accrued interest, Capital stock, other equity related accounts -I/S accounts: interest expense
Acquisition and Payment Cycle
-Relate to usual operations -B/S accounts: Cash in bank, Inventories, Prepaid expenses, Land, Buildings, other asset related accounts I/S accounts: Advertising, Travel and entertainment, Sales meetings and training, Sales and promotional expense, Miscellaneous sales expense, many other operating expenses
Inspection (aka documentation) Evidence
-The auditor's examination of the client's documents and records to substantiate the information that is or should be included in the F/S. -Documentation can be classified as: ¢ Internal ¢ External
Confirmation Evidence
-The receipt of a written or oral response from an independent third party verifying the accuracy of information that was requested by the auditor. This is required for material accounts. -Accounts commonly confirmed: cash, investments, accounts receivable, cash surrender value of life insurance, loans payable, inventory on consignment or in public warehouse -Which determinants of persuasiveness are in operation? - Independence of provider
Observation Evidence
-Use of the senses to assess certain activities -Note that physical examination is a subset of observation -We are watching a process or procedure -Observation is rarely sufficient by itself because: ¢ Risk that knowledge of being observed changes people's behavior ¢ Example: people don't cheat when someone is watching them
What can we learn from analytical procedures during testing?
-When a plausible relationship exists, analytical procedures can be used to test account balances -Depends on: o Significance of account o Predictability of relationship o Reliability of underlying data
When considering the type and amount of audit evidence:
-Which procedures to use? -What sample size to select for a given procedure? -Which items to select from the population? -When to perform the procedures?
For each critical matter communicated in the auditor's report, the auditor must
-identify the critical audit matter. -describe the principal considerations that led the auditor to determine that the matter is a 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.
Assurance Service
-independent professional service that improves the quality of information for decision makers -Can be by CPAs or non-CPAs -Expresses a written or oral conclusion on reliability and relevance of information
Appropriateness of Evidence
-the degree evidence is considered believable or worthy of trust, the measure of quality -appropriateness deals only with the audit procedures selected -it cannot be improved by selecting a larger sample size or different population items -made up by relevance and reliability
1. Duplicate sales invoices 2. Subsidiary accounts receivable records 3. Vendors' invoices 4. General ledgers 5. Title insurance policies for real estate 6. Notes receivable 7. Bank statements 8. Cancelled payroll checks 9. Cancelled notes payable 10. Payroll time cards 11. Purchase requisition 12. Articles of incorporation 13. Receiving reports (documents prepared when merchandise is received) 14. Minutes of the board of directors 15. Signed W-4s 16. Remittance advices 17. Signed lease agreements 18. Duplicate copies of bills of lading
1 I 2 I 3 E 4 I 5 E 6 E 7 E 8 E 9 E 10 I 11 I 12 E 13 I 14 I 15 I 16 E 17 E 18 E
Steps of Phase 1 (Planning and designing) of Audit Planning
1- Accept client and perform initial audit planning 2- Understand the client's business and industry 3- Assess client business risk 4- Perform preliminary analytical procedures 5- Set materiality and assess acceptable audit risk and inherent risk 6- Understand internal control and assess control risk 7- Gather information to assess fraud risks 8- Develop overall audit strategy and audit program
4 categories for an Audit Report:
1. Standard Unqualified 2. Unqualified w/ Emphasis-of-matter, explanatory paragraph, or modified wording 3. qualified 4. adverse or disclaimer
Four major areas in which the AICPA has authority to set standards and make rules are as follows:
1. Auditing standards. The Auditing Standards Board (ASB) of the AICPA is responsible for issuing pronouncements on auditing matters in the U.S. for all entities other than publicly traded companies 2. Preparation, compilation, and review standards. The Accounting and Review Services Committee is responsible for issuing pronouncements of the CPA's responsibilities when associated with financial statements of privately owned companies that are not audited. These pronouncements are called Statements on Standards for Accounting and Review Services, and they provide guidance for performing preparation, compilation, and review services. 3. Other attestation standards. Statements on Standards for Attestation Engagements are standards that may be used to provide assurance on nonfinancial information and are also used to develop standards for specific attestation services. 4. Code of Professional Conduct. The AICPA Professional Ethics Executive Committee sets rules of conduct that CPAs are required to meet.
According to SOX, a client may not engage their auditor for nine specific non-audit services:
1. Bookkeeping and other accounting services 2. Financial information systems design and implementation 3. Appraisal or valuation services 4. Actuarial services 5. Internal audit outsourcing 6. Management or human resource functions 7. Broker, dealer, investment adviser, or investment banker services 8. Legal and expert services unrelated to the audit 9. Any other service that the PCAOB determines by regulation is impermissible
3 "responsibilities" standards for GAAS:
1. COMPETENT The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. 2. INDEPENDENCE Comply with Ethical Requirements (e.g. Code of Professional Conduct). In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. a. Independence is necessary to maintain the value of an audit. 3. DUE PROFESSIONAL CARE is to be exercised in the planning and performance of the audit and the preparation of the report. **The auditor is also required to exhibit professional skepticism throughout the audit.
Types of Auditors and Audit Firms
1. CPAs - external and internal auditors 2. Gov't Accountability Office Auditor - reports to congress and audits gov't operations 3. Internal Revenue Agents - IRS tax auditors 4. Internal Auditors - work for specific companies to audit compliance, efficiency, F/S, etc.
Two Rules for Direct Investments:
1. Covered Persons and their Immediate Families prohibited from ANY direct investment in clients 2. Direct investment of >5% of equity of audit client/affiliates prohibited by all Audit Firm Professionals, their Immediate Family and Close Relatives
Steps in Applying Materiality
1. Determine overall materiality 2. Determine tolerable misstatement 3. Evaluate audit findings
Evaluating Audit Findings in the Materiality Process includes:
1. Estimate total misstated in each account 2. Combine the estimated misstated amounts 3. Compare the combined misstatements with materiality
Steps to evaluate threats to compliance with the "Code"
1. Identify Threats 2. Evaluate the significance of the threat 3. Identify and Apply Safeguards
Quality Control Procedures should address 6 elements:
1. Leadership responsibilities for quality within the firm ("tone at the top") 2. Relevant ethical requirements 3. Acceptance and continuation of client relationships and specific engagements 4. Human resources 5. Engagement performance 6. Monitoring
3 primary types of audits:
1. Operational audit 2. Compliance audit 3. Financial statement audit
Types of Audit Evidence
1. Physical examination 2. Confirmation 3. Inspection 4. Analytical procedures 5. Inquiries of the client 6. Recalculation 7. Reperformance 8. Observation
6 Common Characteristics of Professional Skepticism:
1. Questioning Mindset - sense of doubt 2. Suspension of judgment -withhold judgement until all appropriate evidence obtained 3. Search for Knowledge - a desire to investigate beyond obvious 4. Interpersonal understanding - aware of people's motives and biases 5. Autonomy - drive to decide for oneself 6. Self-esteem - self-confidence to challenge assumptions
5 "Performance" Standards for GAAS:
1. Reasonable Assurance · Auditor must obtain reasonable assurance that the F/S are free from material misstatement, whether caused by error or fraud. 2. The work is to be adequately planned and assistants, if any, are to be properly supervised. 3. Determine and apply materiality appropriately 4. Assess risk of material misstatement - a. A sufficient understanding of internal control is to be obtained to plan the audit and to determine the nature, timing, and extent of tests to be performed. 5. Sufficient appropriate evidence is to be obtained through inspection, observation, inquiries, and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit. a. Decision about quantities and types of evidence to accumulate is based on professional judgment.
Causes of Information Risk
1. Remoteness of information. (how far you are from the source of the info) 2. Biases and motives of the provider. (inconsistent goals among providers and users of information) 3. Voluminous data. (more data means more likelihood than information is improperly recorded) 4. Complex exchange transactions. (accounting becomes more complex to match the transactions, making the information more complex to discern)
According to AICPA standards, a Standard unmodified opinion audit report has 8 parts:
1. Report title including the word "independent" 2. Audit report address 3. Opinion section 4. Basis for opinion 5. Management's Responsibility 6. Auditor's Responsibility 7. Signature and address of CPA firm 8. Audit Report Date (when all significant testing was done)
6 Principles of AICPA Code of Conduct
1. Responsibilities 2. Public Interest 3. Integrity 4. Objectivity and Independence 5. Due Care 6. Scope and Nature of Services
Rate of interest primarily determined by 3 factors:
1. Risk free interest rate (the return on US T. notes) 2. Business risk for customer (risk that business fails) 3. Information risk (risk that information about business is wrong)
4 non-legal reasons for auditing
1. Signaling 2. Monitoring 3. Reducing information risk 4. Insurance Hypothesis
Initial audit planning involves four things, all of which should be done early in the audit:
1. The auditor decides whether to accept a new client or continue serving an existing one. This determination is typically made by an experienced auditor who is in a position to make important decisions. The auditor wants to make this decision early, before incurring any significant costs that cannot be recovered. 2. The auditor identifies why the client wants or needs an audit. This information is likely to affect the remaining parts of the planning process. 3. To avoid misunderstandings, the auditor obtains an understanding with the client about the terms of the engagement. 4. The auditor develops the overall strategy for the audit, including engagement staffing and any required audit specialists.
Three main factors influence the organizational structure of CPA firms:
1. The need for independence from clients. 2. The importance of a structure to encourage competence. 3. The increased litigation risk faced by auditors.
2 "Reporting" standards for GAAS:
1. The report shall either contain an expression of opinion regarding the financial statements, taken as a whole, or an assertion to the effect that an opinion cannot be expressed. When an overall opinion cannot be expressed, the reasons therefore should be stated. In all cases where an auditor's name is associated with financial statements, the report should contain a clear-cut indication of the character of the auditor's work, if any, and the degree of responsibility the auditor is taking. 2. The report shall state whether the financial statements are presented in accordance with generally accepted accounting principles. o The report shall identify those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. o Informative disclosures in the financial statements are to be regarded as reasonably adequate unless otherwise stated in the report.
Steps to develop audit objectives
1. Understand objectives and responsibilities for the audit 2. Divide financial statements into cycles 3. Know management assertions about financial statements 4. Know general audit objectives for classes of transactions, accounts, and disclosures 5. Know specific audit objectives for classes of transactions, accounts, and disclosures
4 DECISIONS about what evidence to gather and how much to accumulate
1. Which audit procedures to use 2. What sample size to select for a given procedure 3. Which items to select from the population 4. When to perform the procedures
Professional Skepticism has 2 components:
1. a questioning mind 2. a critical assessment of audit evidence
AICPA Auditing Standards have 2 classifications:
1. an SAS number to signal its chronological placement compared to other standards(ex: SAS no. 128) 2. an AU-C 3 digit number to signal its location in the Codification (ex: AU-C 610)
Examples of attestation services
1. audits of F/S 2. Reviews of F/S 3. attestation over internal controls 4. others like IT or forecasted F/S attestations
Qualitative Factors to consider for materiality:
1. fraud 2. meeting loan obligations 3. avoiding a loss 4. meeting expectation/estimates 5. maintaining trends
4 assertions related to cash accounts:
1. it exists 2. it is complete 3. client has the rights to it 4. it is accurate
An accountant and his firm are NOT independent when:
1. there is mutual or conflicting interest with an audit client 2. he audits his own work 3. he functions as management or an employee of an audit client 4. he acts as advocate for the audit client
3 ways to reduce information risk
1. user verifies information (physically verify information; usually very costly and impractical) 2. user shares information risk with management (management may be held liable for misleading users) 3. audited F/S are provided (a competent & independent person audits the statements for users)
There are __ Generally Accepted Auditing Standards (GAAS) broken into what 3 categories?
10; 1. Responsibilities (3) 2. Performance (5) 3. Reporting Standards (2)
PCAOB standards have what sort of numbering scheme?
4-digit scheme
Unqualified w/ Emphasis-of-matter, explanatory paragraph, or modified wording report
A complete audit took place with satisfactory results and F/S that are fairly presented, but the auditor believes that is important or is required to provide additional information
Joint closely held investment
A joint closely held investment is an investment by the member and the client that enables them to control the entity or property. A covered member's independence is considered to be impaired if the joint closely held investment is material to the covered member.
Limited Liability Company (LLC)
A limited liability company (LLC) combines the most favorable attributes of a general corporation and a general partnership. An LLC is typically structured and taxed like a general partnership, but its owners have limited personal liability similar to that of a general corporation. All states have LLC laws, and most also allow accounting firms to operate as LLCs.
Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is owned by one or more partners. It is structured and taxed like a general partnership, but the personal liability protection of an LLP is less than that of a general corporation or an LLC. Partners of an LLP are personally liable for the partnership's debts and obligations, their own acts, and acts of others under their supervision. Partners are not personally liable for liabilities arising from negligent acts of other partners and employees not under their supervision. It is not surprising that all of the Big Four firms and many smaller firms now operate as LLPs.
Professional Corporation
A professional corporation (PC) provides professional services and is owned by one or more shareholders. PC laws in some states offer personal liability protection similar to that of general corporations, whereas the protection in other states is minimal. This variation makes it difficult for a CPA firm with clients in different states to operate as a PC.
Center for Audit Quality (CAQ)
A public policy organization affiliated with the AICPA serving investors, public company auditors, and the capital markets. The Center's mission is to foster confidence in the audit process and to make public company audits even more reliable and relevant for investors.
Auditing
A specific type of attestation service, including the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. Auditing should be done by a competent, independent person. The evidence must be sufficient in quantity and quality. The service ends in a written report.
Immediate Family
A spouse, spousal equivalent, or dependent (whether or not related).
Attestation Services
A type of assurance service provided by CPAs which issues a written report about a written subject matter or assertion that is made by another party
supporting schedules
detailed schedules prepared by the client or the auditor in support of specific amounts on the financial statements
relevant evidence
Evidence must be relevant to the audit objective before it can be appropriate. Objective: Are recorded sales for shipments actually made? Relevant Evidence: shipping documents
Undue Influence Threat
Attempts to coerce or otherwise influence the CPA member (e.g., significant gifts or threats to replace the auditor over an accounting principles disagreement).
Network of Firms
Audit firms frequently join larger groups or associations of other firms to enhance their capabilities to provide professional services. When they share certain characteristics, such as a common brand name, common control, common business strategy, or common quality control procedures, or they share in profits, costs, or professional resources, the network firm is required to be independent of audit and review clients of other network firms.
Compare client data with auditor-determined expected results
Example: interest expense ¢ Average LTD balance = $3,000 ¢ Interest rate during period = 5% ¢ Auditor expectation of interest expense: 150 Recorded interest expense: 150
When practical and reasonable, U.S. auditing standards require the confirmation of: A) individual transactions between organizations, such as sales transactions. B) accounts receivable. C) fixed asset additions. D) payroll expenses.
B. Accounts Receivable
Purposes of Audit Documentation
Basis for planning the audit Record of the evidence accumulated and the results of the tests Data for determining the proper type of audit report Basis for review by supervisors and partners
inventory and warehousing cycle
B/S Accounts: inventory I/S accounts: COGS
Payroll and Personnel Cycle
B/S accounts: Cash in bank, Accrued payroll, Accrued payroll taxes I/S accounts: Salaries and commissions, Sales payroll taxes, Executive and office salaries, Administrative payroll taxes
sales and collection cycle
Balance sheet accounts: Cash in bank, Trade accounts receivable, Other accounts receivable, Allowance for uncollectible accounts Income Statement Accounts: Sales, Sales returns and allowances, Bad debt expense
PCAOB Standard unqualified Opinion audit report differences vs AICPA
Can include opinion from audit on internal controls. Basis for opinion section usually shorter and less detailed. CAMs are required. Must disclose how long the firm has audited the client.
Committee of Sponsoring Organizations of the Treadway Commission (COSO)
Committee that issues framework for auditing internal controls, called the "Internal Control-Integrated Framework"
Reduce Information Risk
Companies want to reduce information risk so they can secure lower interest rates on borrowed money. So they get their F/S audited to accomplish this.
Audit Planning Phase 4:
Complete the audit and issue an audit report
Completeness (mgmt assertion)
Concern is with whether all transactions and balances that should be recorded are actually recorded This is the opposite of the existence and occurrence assertion. Typically a concern for liabilities and expenses - balances that are understated
Materiality is a concept set by the
FASB
Analytical Procedures
Evaluations of financial information made by a study of plausible relationships among financial and non-financial data ... involving comparisons of recorded amounts to expectations developed by the auditor (SAS 56; AU 329). -Required during planning and completion phase of audit -Can be used as an audit procedure during fieldwork or testing phase
Quality Control (QC)
For a CPA firm, quality control comprises the methods used to ensure that the firm meets its professional responsibilities to clients and others. These methods include the organizational structure of the CPA firm and the procedures the firm establishes.
robotics
New technologies are now emerging that allow machines to be used like assembly line robots except they are now being used to perform traditional business office processes, such as data entry and manipulation tasks that are common to many transaction cycles.
SOX requirements for BoD and Officers:
New: CEO and CFO must certify financial reports (§302) CEO/CFO must forfeit bonuses and profits on stock sales if issuer is required to issue a restatement due to misconduct Prohibited from trading during pension "blackout" periods Not new, but now law: Prohibited from fraudulently misleading auditors SEC can bar "unfit" officers and directors
_____ are needed for evaluating materiality
benchmarks; Primary Benchmark: net income before taxes (5% rule of thumb); also use: net sales, gross profit, net assets
litigation between CPA firm and client
In situations where management sues a CPA firm claiming a deficiency in the previous audit, the CPA firm is not considered independent for the current year's audit. Similarly, if the CPA firm sues management for fraudulent financial reporting or deceit, the audit firm is no longer independent.
Objective of an Audit
Provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial accounting framework (GAAP), which enhances the degree of confidence that intended users can place in the financial statements
Integrity and Objectivity Rule
In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others.
Unpaid Fees
Independence is considered impaired if billed or unbilled fees remain unpaid for professional services provided more than one year before the date of the report. Unpaid fees from a client in bankruptcy DO NOT violate independence.
reasonable investor rule
Independence violated if in light of all relevant facts & circumstances, a reasonable investor would conclude that the auditor would not be capable of acting without bias
Attest engagement team
Individuals (from audit, tax, consulting, and clerical) participating in the attest engagement including those performing concurring and 2nd partner review
Is A bank reconciliation internal or external document?
Internal
what is often the primary benchmark for deciding what is material for profit-oriented businesses
Net income before taxes
Cycle Approach to segment an audit
Keep closely related types (or classes) of transactions and account balances in the same segment. For example, sales, sales returns, cash receipts, and charge-offs of uncollectible accounts are the four classes of transactions that cause accounts receivable to increase and decrease.
Monitoring (Principal-Agent Model)
Management will get attesters to attest to the quality of their work so that the owners will pay them more.
Independence rules for contingent fees:
Members in public practice shall not: ¢ Perform any professional services for a contingent fee ¢ Prepare an original or amended tax return for a contingent fee **You can offer contingent fees for other services unless it is for an audit client
Examples of Assurance Services provided by CPAs and non-CPAs
Mystery shopping, Organic ingredients, Corporate responsibility and sustainability
Proprietorship
Only firms with one owner can operate in this form. One-owner firms were traditionally organized as proprietorships, but most have changed to other organizational forms with more limited liability because of litigation risks.
Critical Audit Matters (CAMs)
PCAOB auditing standards define a critical audit matter as "any matter arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment." CAMs are required to be disclosed by the PCAOB, but not AICPA.
Audit planning phase 2:
Perform tests of controls and substantive tests of transaction
Audit planning phase 1:
Plan and design an audit approach based on risk assessment procedures
Signaling
Producers get assurance for their products to prove it is a high quality so they can command a higher price.
Audit Documentation
Record of the audit procedures performed, relevant audit evidence, and conclusions the auditor reached. Audit documentation should include all the information the auditor considers necessary to adequately conduct the audit and to provide support for the audit report.
The SEC requirements of greatest interest to CPAs are set forth in the commission's
Regulation S-X, Staff Accounting Bulletins, and Accounting and Auditing Enforcement Releases.
In some cases, if accounts are more expensive to audit, auditors want to look for bigger errors to balance the costs and benefits
Results in setting performance materiality (or tolerable misstatement) higher
In other cases, the auditor may have reason to believe that only smaller errors will exist, but there will be many of them.
Results in setting performance materiality (or tolerable misstatement) lower
Name and describe audit objective for Rights and obligations assertion
Rights and obligations; same concept as assertion
Statements on Auditing Standards
Statements issued by the AICPA's Auditing Standards Board for the audit of private companies. The AICPA's standards are also referred to as GAAS (generally accepted auditing standards).
Adverse Audit Report
The auditor concludes that the F/S are not fairly presented
Qualified Audit Report
The auditor concludes that the overall F/S are fairly presented, but the scope of the audit has been materially limited or applicable accounting standards were not followed in preparing the F/S
Minutes of meetings
The auditor should read the minutes to obtain authorizations and other information that is relevant to performing the audit. This information should be included in the audit files with significant portions highlighted.
Reliability of evidence
The degree to which evidence is believable or trustworthy. Factors: 1. independence of provider 2. effectiveness of client's internal controls 3. auditor's direct knowledge 4. qualifications of individuals providing the info 5. degree of objectivity 6. timeliness
Audit principles vs standards
The principles underlying auditing standards are too general to provide meaningful guidance, so auditors turn to the auditing standards issued by the AICPA and the PCAOB for more specific guidance. Auditing standards are regarded as AUTHORITATIVE literature. Both the principles and standards should be viewed as the MINIMUM STANDARD for audit work.
Risk of Material Misstatement
The pre-audit risk that the entity's financial statements contain a material misstatement whether caused by error or fraud.
Adverse interest threat
The threat that a member will not act with objectivity because the member's interests are opposed to the attest client's interests.
Self-review threat
The threat that a member will not appropriately evaluate the results of a previous judgment or service performed or supervised by the member or an individual in the member's firm and that the member will rely on that service in forming a judgment as part of another service.
Advocacy threat
The threat that a member will promote an attest client's interest or position to the point that his or her objectivity or independence is compromised.
Assurance Services
These assurance services differ from attestation services in that the CPA is not required to issue a written report, and the assurance does not have to be about the reliability of another party's assertion about compliance with specified criteria.
Indirect effect illegal acts
These illegal acts affect the financial statements indirectly. Example: Violations of environmental protection laws ¢ There is an effect only if there is a fine or sanction **Auditors provide no assurance that indirect-effect illegal acts will be detected.
Direct Effect Illegal Acts
These illegal acts have a direct financial effect on specific account balance(s) in the financial statements - Example: violations of federal tax laws - Auditor's responsibility for direct-effect illegal acts is the same as for fraud.
General Partnership
This form of organization is the same as a proprietorship, except that it applies to multiple owners. This organizational structure has also become less popular as other forms of ownership that offer some legal liability protection became authorized under state laws.
Engagement Letter
This letter sets forth the understanding with the client, including in particular (1) the objectives of the engagement, (2) management's responsibilities, (3) the auditors' responsibilities, and (4) any limitations of the engagement.
Form 8-K
This report is filed to report significant events that are of interest to public investors. Such events include the acquisition or sale of a subsidiary, a change in officers or directors, an addition of a new product line, or a change in auditors.
Form 10-K
This report must be filed annually within 60 to 90 days after the close of each fiscal year, depending on the size of the company. Extensive detailed financial information, including audited financial statements, is contained in this report.
Form 10-Q
This report must be filed quarterly for all publicly held companies. It contains certain financial information and requires auditor reviews of the financial statements before filing with the commission.
Opinion Shopping
When a client seeks out the views of various accountants until finding one who will go along with the client's desired accounting treatment and then choosing that accounting firm as their auditor.
Vouching
When auditors use documentation to support recorded transactions or amounts
Working trial balance
a listing of the general ledger accounts and their year-end balances
Acceptable Audit Risk (AAR)
a measure of how willing the auditor is to accept that the financial statements may be materially misstated after the audit is completed and an unqualified opinion has been issued
Ethics
a set of moral principles or values
SEC requires public company auditors to maintain the following documentation:
Working papers or other documents that form the basis for the audit of the company's annual financial statements or review of the company's quarterly financial statements Memos, correspondence, communications, other documents and records, including electronic records, related to the audit or review
SOX-related guidelines for pro forma info:
You MUST reconcile pro forma info with GAAP! -Pro forma earnings exclude GAAP items that management deems nonrecurring or non-representative -Firms Change definition of what included/excluded in pro forma earnings from period to period -Pro forma earnings are always greater than GAAP
review of historical financial statements
a form of attestation in which a CPA firm issues a written report that provides cheaper and less assurance than an audit as to whether the financial statements are in material conformity with accounting standards
Materiality is not an _____, it requires _____ ______, and ____ by audit.
absolute; professional judgement; varies
Name and describe audit objective for accuracy, valuation and allocation assertion
accuracy; price, quantities, and math are correct *and* Cutoff; transactions are recorded in the correct period *and* detail tie-in; details in account balances agree with master file and general ledger *and* Realizable value; assets are carried at amounts estimated to be realized
Supporting schedules for audit documentation include:
analysis, trial balance list, Reconciliation of amounts, Substantive analytical procedures, summary of procedures, Examination of supporting documents, other informational or outside documentation
SEC
appoints and oversees PCAOB; assists in providing investors with reliable information upon which to make investment decisions
The persuasiveness of evidence can be evaluated only after considering the combination of ___ and ___
appropriateness; sufficiency -For example, an auditor could have a large sample of objective evidence, but the evidence is not relevant --- so the evidence is not persuasive
According to SOX, auditors must ______ to internal control effectiveness reports on a ______ basis
attest; yearly
The AICPA requires independence only for _______ engagements.
attestation
Substantive tests of transactions
audit procedures testing for monetary misstatements to determine whether the seven transaction-related audit objectives have been satisfied for each class of transactions
Audit documentation files are the property of the
auditor. No one else has a right to access unless subpoenaed by a court, or they are being used for peer review or by a regulatory agency. The files should remain confidential.
One way to think of audit vs attestation vs assurance
audits are performed to discover data, risks, or compliance issues that may not have been known before the audit took place, attestation is to evaluate and review how true the data or information is when compared to a stated purpose, internal control or system, assurance is simply an unbiased opinion on some information, without any stated basis or criteria, which improves users' confidence in the information
In a financial statement audit, the auditor obtains a reasonable level of assurance about whether the financial statements are free of material misstatement in order to express an opinion. In order to obtain reasonable assurance, the auditor must a. Have prior experience in the industry in which the audit client operates b. Examine all documents available that support the financial statements c. Obtain sufficient audit evidence d. Test controls around significant transaction cycles
c. Obtain sufficient audit evidence
Cash Ratio
cash + marketable securities / current liabilities
Current Ratio
current assets divided by current liabilities
Assertion
declaration stated positively but with no support or attempt at proof.
Occurrence (mgmt assertion)
did recorded income statement transactions actually happen during the accounting period *typically a concern for revenues
Name and describe audit objective for Existence assertion
existence; same concept as assertion
Is a bank statement an external or internal document?
external
Purpose of allocating the preliminary judgment of materiality to accounts is to
help the auditor decide the appropriate evidence to accumulate for each account. An aim of allocation is to minimize audit costs without sacrificing quality.
Close Relative
immediate family, plus parents, siblings or nondependent children
Define Management Assertions
implied or expressed representations by management about classes of transactions, related account balances, and presentation and disclosures in the financial statements **The audit's goal/purpose is to test whether management's assertions are materially true
Materiality level can be impacted by:
industry standards, client size, whether the client is public or private
machine learning
involves the use of statistical techniques that allow the computer to "learn" from the data to progressively improve the performance of a specific task.
Peer Review
is the review, by CPAs, of another CPA firm's compliance with its quality control system. Unless a firm has a peer review, all members of the CPA firm lose their eligibility for AICPA membership.
the overall objective of audit documentation
is to aid the auditor in providing reasonable assurance that an adequate audit was conducted in accordance with auditing standards.
Audit Program
list of audit procedures for an audit area or an entire audit; the audit program always includes audit procedures and may also include sample sizes, items to select, and timing of the tests. Normally, there is an audit program, including several audit procedures, for each component of the audit. Therefore, there will be an audit program for accounts receivable, one for sales, and so on.
Sufficiency of evidence
measure of the quantity of evidence; as sample size increases, sufficiency increases; but qualitatively, is the sample representative of the population?
2 types of fraud
misappropriation of assets and management fraud (fraudulent financial reporting)
effective internal controls reduce the likelihood of
misstatements in F/S
The Rules of Conduct of the AICPA code are
more precise and specific than the principles and are the minimum standard for satisfactory conduct
Audit Documentation files
must be maintained for 5 years for private companies and 7 years for public. Willful destruction before the period is up is a criminal offense.
Account Receivable Turnover
net credit sales/average net accounts receivable
Client Acceptance
obtain an understanding with client (engagement letter), determine engagement staff, assess need for specialists, access timeframe
Phase 3 of audit process
perform substantive analytical procedures and tests of details of balances
Phase 2 of audit process
perform tests of controls and substantive tests of transactions
Principles underlying an audit according to the ASB
provide a framework to help auditors fulfill the following two objectives when conducting an audit of financial statements: - Obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are presented fairly, in all material respects, in accordance with an applicable financial reporting framework; and - Report on the financial statements, and communicate as required by GAAS, in accordance with the auditor's findings.
The purpose of an audit is to
provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial accounting framework, which enhances the degree of confidence that intended users can place in the financial statements.
The Securities Exchange Act of 1934
provides additional protection by requiring public companies and others to file detailed annual reports with the commission.
Materiality has both a _____ and ______ nature
quantitative; qualitative
appropriateness of evidence has two factors:
relevance and reliability
Securities Act of 1933
requires most companies planning to issue new securities to the public to submit a registration statement to the SEC for approval.
Auditors will often change to a _____ _______ ______ materiality
revised judgement about
Factoring Accounts Receivable
selling receivables to a collection company for cash now
Audit Strategy
sets the scope, timing, and direction of the audit and that guides the development of the audit plan. This strategy considers the nature of the client's business and industry, including areas where there is greater risk of significant misstatements.
footing
summing a column vertically
cross-footing
summing a row horizontally
deep learning
technologies where computers are trained to recognize large amounts of data that would be impossible for humans to process. Advances in computational power and data storage are now making it possible for machines to process reams of data in a manner that models the structure and thinking process of the human brain.
Materiality considerations are also important when evaluating results during
testing phase (estimating total misstatement in segment/account, estimating aggregated misstatement, comparing aggregated estimate to preliminary/revised materiality).
Disclaimer Audit Report
the auditor is unable to form an opinion as to whether the F/S are fairly presented, or the auditor in not independent.
tracing
the auditor traces from receiving reports to the acquisitions journal to satisfy the completeness objective
Who pays fees to keep PCAOB running?
the companies who issue the financial statements
Audit Procedure
the detailed instruction that explains the audit evidence to be obtained during the audit
Audit documentation should identify:
the items tested, any significant audit findings or issues, actions taken to address them, and the basis for the conclusions reached
Preliminary judgement about materiality
the maximum amount by which the auditor believes that the statements could be misstated and still not affect the decisions of reasonable users; used in audit planning; the lower the dollar amount, the more evidence required
The smaller a materiality threshold,
the more work the auditor must do
Information Risk
the probability that the information we use to make a decision was incorrect
Judgement
the process of reaching a decision or drawing a conclusion where there are a number of possible alternatives or solutions
Client business risk
the risk that the client will fail to achieve its objectives related to (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with laws and regulations
US supreme court deems a fact is material if
there is "a substantial likelihood that the...fact would have been viewed by the reasonable investor as having significantly altered the 'total mix' of information made available."
information asymmetry
those who issue the information know more about it than those who use it, so we have audits to give users of the information more confidence
Name and describe audit objective for Cutoff assertion
timing; same concept as assertion, but must note the name change
There are three main reasons why the auditor should properly plan engagements:
to enable the auditor to obtain sufficient appropriate evidence for the circumstances, to help keep audit costs reasonable, and to avoid misunderstandings with the client.
Analytical Procedures are
used extensively in practice, and are required during the planning and completion phases on all audits.
Performance Materiality (tolerable misstatement)
usually evaluated at the segment or account level; commonly 50-75% of materiality; amount set by the auditors at less than materiality for accounts (or individual financial statements) to reduce to an appropriately low level that the probability that the aggregate of uncorrected and undetected misstatements exceed materiality for the financial statements as a whole
Indirect financial interest
when a person owns shares of a client through another entity or has a mutual interest with a client
Rights and Obligations (mgmt assertion)
whether all recorded assets are the rights of the entity and all recorded liabilities are the obligations of the entity at a given date (B/S date). *EX: So, are trade accounts receivable owned by the company at 12/31 or have they been sold or factored?
Independence-related rules for employment:
¢ Covered Person and their Close Relatives prohibited from Key Positions in audit client ¢ Former partner or professional employee prohibited from Key Positions - one year cooling off period required by SOX ¢ Former audit client employees prohibited from becoming partner in audit firm and being involved in audit
Independence related disclosure requirements:
¢ Disclose fees paid to auditor for audit, audit-related, tax and all other services provided ¢ State whether audit committee has considered whether provision of non-audit services is compatible with maintaining independence
Individual in position to influence engagement team includes anyone who:
¢ Evaluates performance or recommends compensation of engagement partner ¢ Directly supervises/manages engagement partner (all the successively senior people in firm) ¢ Consults with engagement team on technical or industry-related matter ¢ Participates in quality control activities
Auditor's Responsibility relating to F/S (AS 1001.02)
¢ Express an opinion on the financial statements ¢ To plan and perform audit to obtain reasonable assurance about whether F/S are free of material misstatement, whether caused by error or fraud ¢ To obtain reasonable, but not absolute, assurance that material misstatements are detected **Detect fraud, unintentional mistakes, and consider laws and regulations ¢ Auditor has no responsibility to plan/perform audit to obtain reasonable assurance in detection of immaterial error or fraud
Management's Responsibility relating to F/S (AS 1001.01)
¢ Fairly present Financial statements ¢ Adoption of sound accounting policies ¢ Establishment and maintenance of internal control system that will initiate, record, process, and report transactions consistent with management's assertions **must personally certify yearly and quarterly statements
Covered members include
¢ Individual on the engagement team ¢ Individual in position to influence the engagement team (see below) ¢ Partner or manager who provides > 10 hours non-attest services ¢ Partner in the office of the lead engagement partner ¢ The firm, including the firm's employee benefit plans
Other situations where independence is impaired:
¢ Loans to/from audit client prohibited except consumer loans (mortgages & car loans) ¢ Bank, brokerage accounts > insured amounts prohibited ¢ Credit card balances >$10k prohibited ¢ Holding insurance policies and firm's professional liability policies prohibited
misappropriation of assets
¢ Occurs when employees convert (i.e., steal, cheat) company assets for their own benefit - Typically lower-level employees - AKA: defalcation or employee fraud ¢ Note: must distinguish between the theft of assets and misstated F/S resulting from the theft of assets.
Compare client data with expected results, using non-financial data
¢ The auditor uses a relationship between nonfinancial data and financial data to form an expectation and compares to recorded balance. ¢ Auditor makes a projection (based on historical patterns) and compares to actual balance. ¢ Example: Rental income for an apartment complex monthly rent x # units x occupancy rate = estimate of monthly rent
Compare client data with client-determined expected results
¢ Usually involves comparison to budgets ¢ Good for governmental agencies
Management Fraud
¢ When company manipulates the F/S so they diverge from actual economic reality (i.e., so they look better than events support) - Usually done by upper-level management - AKA: irregularity or fraudulent financial reporting
Several Factors to consider when allocating materiality:
• Auditors expect certain accounts to have more misstatements than others • Both overstatements and understatements must be considered • Relative audit costs affect the allocation
The sum of performance materiality across all accounts can exceed overall materiality because:
• It is unlikely that all accounts will be misstated by full amount of performance materiality • Some accounts are likely to be overstated while others are likely to be understated (due to double entry bookkeeping), resulting in a smaller net amount • Additional testing likely performed when errors identified. • Overall materiality serves as a "safety net."
Perform Preliminary Analytical Procedures
•Consider key financial ratios: -Over time -vs. competitors -vs. industry averages -Compared to benchmarks/budgets
Why do we allocate materiality?
•Decide the appropriate amount of evidence to accumulate for each account •Aim to minimize audit costs without sacrificing audit quality •It is not an exact science!!
Evaluating Audit Findings for Materiality
•Known vs. Likely misstatements • Known - specific misstatements the auditor found • Likely - 1. Differences in estimates between auditor and management; 2. Projections of misstatements based on sampling • Comparisons done at BOTH the performance materiality level and the materiality level • If the aggregate misstatement is less than overall materiality, the auditor can conclude that the financial statements are fairly presented • If the aggregate misstatement is more than overall materiality, then the auditor recommends adjustments be made to the F/S before a clean opinion can be issued.
Understand the Client's Business and Industry and Assess the Client's Business Risk
•Recent changes in the economic conditions •Information technology risks •Scale of business operations - global? •Areas of management judgment and accounting complexity •Specific industry risks •Unique accounting requirements •Related parties •Management structure - including Tone at the Top •The Company's business objectives and strategies for achieving those objectives •The Company's key performance indicators
Basic Preliminary Planning Procedures
•Understand the Client's Business and Industry •Assess Client's Business Risk •Perform Preliminary Analytical Procedures
