audit midterm

The AICPA __________ require(s) specific quality control procedures.

does not

The four basic requirements for becoming a CPA in most states are

education, the CPA Examination, experience, and a state certificate.

Tests of controls are performed to determine whether key controls operate __________.

effectively

Operational auditing is oriented primarily toward...

efficiency and future improvements to accomplish the goals of management.

The auditor's report is the __________ of an audit.

end product

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

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

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

nature of relationship description of transactions terms and manner of settlement

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

nature, timing, and extent of further audit procedures

The study of business operations for the purpose of making recommendations about the efficient use of resources, effective achievement of business objectives, and compliance with company policies is referred to as

operational auditing.

An auditor's report includes an introduction, the auditor's and management's responsibility, and a(n) __________.

opinion

In order to be considered as external auditors with respect to government agencies, GAO auditors must be

organizationally independent.

report release date is the date the client is granted

permission to use the report

Audit __________ begins with determining the requirements for the engagement.

planning

When testing the completeness assertion for a liability account, an auditor ordinarily works from the

potentially unrecorded items to the financial statements.

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

precision detailed ex. use monthly data rather than annual

During an audit of an entity's stockholders' equity accounts, the auditor determines whether there are restrictions on retained earnings resulting from loans, agreements, or state law. This audit procedure most likely is intended to verify management's assertion of

presentation and disclosure.

working papers

procedures findings conclusion

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

"Fair Value Measurements and Disclosures" - FASB ASC

Rule 101

"covered members" must be independent If a partner or professional leaves a firm to work at a client's office, the relationship is no impaired

The SEC's rules with respect to services provided by auditors are predicated on three basic principles of auditor objectivity and independence. What are the three basic principles?

(1) an auditor should not audit his or her own work (2) an auditor should not function in the role of management (3) an auditor should not serve in an advocacy role for his or her client.

Level 3

*inputs that are UNOBSERVABLE for the assets or liabilities

Level 2

*quoted prices for SIMILAR assets of liabilities*

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

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

Audits may be characterized as (a) financial statement audits, (b) compliance audits, or (c) operational audits. The work can be done by (a) independent (external) auditors, (b) internal auditors, or (c) government auditors. Below is a list of several audit engagements. For each engagement indicate (a) the type of audit and (b) who would typically do the audit. Review contract cost of constructing aircraft engines for the United States armed services.

- Type of audit: Operational audit - Typical author: Independent (CPA)

Administrative working papers

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

Assertions with high inherent risk

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

Indications of High Inherent risk

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

Evidence is more reliable when

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

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

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

Relevant assertions

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

Which of these statements concerning illegal acts by clients is correct? A.) An auditor considers illegal acts from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions. B.) An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud. C.) An auditor has no responsibility to detect illegal acts by clients that have an indirect effect on the financial statements. D.) An audit in accordance with generally accepted auditing standards normally includes audit procedures specifically designed to detect illegal acts that have an indirect but material effect on the financial statements.

B.) An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud.

Which of the following would an auditor most likely use in determining overall materiality when planning the audit? A.) The anticipated sample size of the planned substantive tests. B.) The entity's income before taxes for the period-to-date (e.g., 6 months). C.) The results of tests of controls. D.) The contents of the engagement letter.

B.) The entity's income before taxes for the period-to-date (e.g., 6 months).

As generally conceived, the audit committee of a publicly held company should be made up of A.) the audit partner, the chief financial officer, the legal counsel, and at least one outsider. B.) members of the board of directors who are not officers or employees. C.) representatives of the major equity interests (preferred stock, common stock). D.) representatives from the entity's management, investors, suppliers, and customers.

B.) members of the board of directors who are not officers or employees.

Material & Indirect Illegal Acts

Be aware of what may have occurred; investigate if brought to attention

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

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

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

Completeness

The audit objective that all balances include all items that should be recorded in that account is related most closely to which one of the ASB balance assertions?

Completeness

The audit objective that all transactions and accounts that should be presented in the financial statements are in fact included is related to which of the PCAOB assertions?

Completeness

The auditor obtains an understanding of the entity and its environment by performing all of the following assessment procedures except

Compute the level of detection risk

Direct & Material Illegal Acts

Consider laws and regulations as part of audit

Audit evidence regarding management assertions

Consists of underlying accounting data & additional information available to the auditor Relevence Reliability

An audit report indicates that the audit evidence we have obtained is __________ to provide a basis for the opinion.

sufficient

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

supervision

Test of Controls

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

The accounting, auditing, and investigating agency of the U.S. Congress, headed by the U.S. Comptroller General, is known as

the U.S. General Accountability Office (GAO).

The Sarbanes-Oxley Act of 2002 requires that the key company officials certify the financial statements. Certification means that the company CEO and CFO must sign a statement indicating

all of these.

Scanning

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

Corroborating Documents

articles of incorporation mortgages, audit confirmations, representation letters

3. Confirmation of receivables by an auditor fails to detect a material misstatement.

detection risk

6. A necessary substantive audit procedure is omitted.

detection risk

risk that exists only if audit happens

detection risk

Assertions about ACCOUNT BALANCES

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

4. compare client GP % to industry average

Misstatement of sales and accounts receivable Misstatement of COGS and inventory

3. compare AR turnover for this year to last

Misstatement of sales or AR Misstatement of Allowance for doubtful accounts

Assertions about Classes of Transactions

Occurrence completeness accuracy cutoff classification - not rights and obligations

Changes in a client's accounting choices either affect "consistency" in the application of GAAP or they do not. For each item listed below, state whether the item affects consistency and identify the effect the change will have on the audit report. 1) Change in accounting estimate 2) Correction of an error in principle 3) Change in reporting entity 4) Correction of an error that does not involve an accounting principle 5) Change in accounting principle 6) Change in classification and reclassification 7) Change expected to have a material future effect

1) does not affect consistency and no modification to the audit report is required 2) affects consistency and an explanatory paragraph 3) affects consistency and an explanatory paragraph 4) does not affect consistency and no modification to the audit report is required 5) affects consistency and an explanatory paragraph 6) does not affect consistency and no modification to the audit report is required 7) does not affect consistency and no modification to the audit report is required

Standards of field work

1. Adequate planning & supervised assistants 2. Obtain sufficient understanding of internal controls (nature, time, extent) 3. Obtain sufficient appropriate evidential matter

What are the three general auditing standards found within the 10 GAAS (NOT the three main categories of GAAS) and why is each important?

1. Adequate training & proficiency 2. Maintain independence 3. Due Professional Care- degree of skill

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

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

Planning the Audit Steps

1. Assess business risks. 2. Establish materiality. 3. Consider multilocations. 4. Assess the need for specialists. 5. Consider violations of laws and regulations. 6. Identify related parties. 7. Consider additional value-added services. 8. Document the overall audit strategy, audit plan, and prepare audit programs.

Two forms of ratio analysis

1. horizontal 2. cross sectional

Steps in Applying Materiality on an Audit

1. Determine overall materiality 2. Determine tolerable misstatement 3. Evaluate audit findings

Preliminary Engagement Activities

1. Determine the audit engagement team requirements 2. Assess compliance with ethical & independence requirements 3. Establish understanding with entity

Representation Letter from client

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

8 other audit procedures?

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

Elements of Quality Control

1. Leadership: tone at the top 2. Relevant Ethical Requirements 3. Acceptance & Continuance of Entity Relations 4. Human Resources 5. Engagement Performance 6. Monitoring

Read the stages of an audit listed below and put them in the correct order:

1. Plan the Audit 2. Obtain an understanding of the client and it's environment including internal control 3. Assesses the risk of misstatement and design further audit procedures 4. Perform further audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report

Purpose of Representation Letter 1. Primary 2. others

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

3 types of transactions and their inherent risk levels

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

In establishing the terms of the engagement, three topics must be discussed:

1. The engagement letter 2. Using the work of the internal audit function 3. The role of the audit committee.

Put the following components of the standard auditors' report in the correct order:

1. Title 2. Introduction 3. Management's Responsibility for the Financial Statements 4. Auditor's Responsibility 5. Opinion

current file order of docs

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

4 categories of working papers

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

2 things auditors should consider when determining extent of analytical procedures

1. cost benefit 2. effectiveness

working papers assist 3 people

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

4 steps to analytical procedure

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

3 purposes of a permanent file

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

Three ways to evaluate estimations

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

Audit risk = ____ + ______

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

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

60 days Documentation completion date

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

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

The auditor has a duty to disclose the information to parties outside the entity in all of the following circumstances except

A Wall Street analyst inquiry regarding future profit projections

The textbook presented the concept of auditing through an analogy that involved buying a house and hiring a house inspector. Name three desirable qualities of a house inspector or an auditor and discuss how those qualities apply to an auditor and why those qualities are important for an auditor to possess.

A house inspector should have knowledge A house inspector should honest A house inspector should no be careless

Which of the following represents a factual misstatement?

A misstatement found by the auditor that is due to incorrect pricing on a sales invoice

If the independent auditors decide that it is efficient to consider how the work performed by the internal auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal auditors' A.) competence and objectivity. B.) efficiency and experience. C.) independence and review skills. D.) training and supervisory skills.

A.) Competence and objectivity.

Communication between predecessor and successor auditors aids in evaluating the __________ of management. A.) integrity B.) competence C.) indepedence D.) frugality E.) objectivity

A.) Integrity

Tolerable misstatement is A.) materiality used to establish a scope for the audit procedures for the individual account balance or disclosures. B.) materiality for the income statement as a whole. C.) materiality for the balance sheet as a whole. D.) the amount of misstatement that management is willing to tolerate in the financial statements.

A.) materiality used to establish a scope for the audit procedures for the individual account balance or disclosures.

Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States? ASB PCAOB _________________________________________________________________________________ 1. Public company audits Nonpublic company audits 2. Nonpublic company audits Public company audits 3. Public company audits Public company audits 4. Nonpublic company audits Nonpublic company audits

ASB: Nonpublic company audits PCAOB: Public company audits

According to PCAOB Auditing Standard No. 5 (AS 5), the auditor should identify significant accounts and disclosures and their relevant assertions. Which of the following financial statement assertions is not explicitly identified in AS 5?

Accuracy

"Related Party Disclosures"

Affiliates of the enterprise. Entities using equity method to account for investments. Trusts for benefit of employees. Principal owners of enterprise. Management. Immediate families of the principal owners and management. Other parties that can have significant influence.

Principals & Agents relationship leading to demand for auditors

Agents- managers Principals- stockholders Conflict of interest Principal hires agents to manage resources. Agents hire auditors to report on fairness of FS. Auditors gather evidence & add credibility.

When the audit evidence is gathered, the auditor:

Aggregates misstatements from each account or class of transactions (including known and likely misstatements). Considers the effect of misstatements not adjusted in the prior period. Compares the aggregate misstatement to overall materiality. If the aggregate misstatement is less than overall materiality, the auditor can conclude that the financial statements are fairly presented, if not, an adjustment should be made.

If the auditor determines that a material misstatement may be due to fraud, the auditor should do all of the following except

Alert the authorities

Audit risk is typically considered and assessed

All of the above, - at the assertion level, - at the accounts balance level, - for financial statements as a whole

The Sarbanes-Oxley Act of 2002 generally prohibits public accounting firms from

All of the above.

Which of the following is an underlying condition that in part creates the demand by users for reliable information?

All of these

Which of the following is not an ASB assertion about inventory related to presentation and disclosure?

All of these are ASB presentation and disclosure assertions about inventory.

Preliminary engagement activities include...

All of these: understanding the client and the client's industry, determining audit engagement team requirements, ensuring the independence of the audit team and audit firm.

Common- Size Income Statement

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

Pervasive effects on the financial statements are those that:

Are not confined to specific elements, accounts, or items of the financial statements; If so confined, represent or could represent a substantial proportion of the financial statements; or With regard to disclosures, are fundamental to users' understanding of the financial statements.

Example of Inquiry

Asking personnel about their operations

Additional Emphasis

An auditor may want to emphasize a specific matter regarding the financial statements even though he or she intends to express an unqualified/unmodified opinion. Explanatory paragraph

Which of the following is a misappropriation of assets?

An employee of a consumer electronics store steals 12 CD players

Covered Members

An individual on the attest engagement team An individual in a position to influence the attest engagement A partner or manager who provides nonattest services to the attest entity beginning once he or she provides 10 hours of nonattest services A partner in the office in which the lead attest engagement partner primarily practices in connection with the attest engagement The firm, including the firm's employee benefits plan An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described above or by two or more such individuals or entities if they act together

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

Analytical substantive procedures

Holding out

Any action initiated by a member that informs others of his or her status as a CPA or AICPA-accredited specialist.

Representation letters are dated as of the date of the ___

Audit report

What is the difference between audit risk and engagement risk?

Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated Engagement risk is the auditor's exposure to loss or injury to professional practice from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on

Which of the following best describes the relationship between auditing and attestation engagements?

Auditing is a subset of attestation engagements that focuses on the certification of financial statements.

Which of the following best describes relationships among auditing, attest, and assurance services?

Auditing is a type of assurance service.

9 Categories of Prohibited Nonaudit Services

Bookkeeping Actuarial Services Broker or Dealer Financial Info Systems Design & Impl Internal Audit Outsourcing Services Legal Services Appraisal or Valuation Management Functions or HR Expert Services

If predecessor auditors refuse communication, successor auditors __________ accept the engagement. A.) can B.) must not C.) cannot D.) should not

C.) Cannot (IDK)

When planning an audit, an auditor should A.)evaluate detected misstatements. B.) consider whether the extent of substantive procedures may be reduced based on the results of tests of controls. C.) determine overall materiality for audit purposes. D.) conclude whether changes in compliance with prescribed internal controls justify reliance on them.

C.) determine overall materiality for audit purposes.

During the initial planning phase of an audit, a CPA most likely would A.) identify specific internal control activities that are likely to prevent fraud. B.) evaluate the reasonableness of the entity's accounting estimates. C.) discuss the timing of the audit procedures with the entity's management. D.) inquire of the entity's attorney if it is probable that any unrecorded claims will be asserted.

C.) discuss the timing of the audit procedures with the entity's management.

Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's A.) evaluation of all matters of continuing accounting significance. B.) awareness of the consistency in the application of generally accepted accounting principles between periods. C.) understanding as to the reasons for the change of auditors. D.) opinion of any subsequent events occurring since the predecessor's audit report was issued.

C.) understanding as to the reasons for the change of auditors.

Which of the following is not one of the three conditions that are generally present when fraud occurs?

Collusion

Vertical Analysis is a

Common- Size income Statement

Which of the following is an example of fraudulent financial reporting?

Company management falsifies inventory count, thereby overstating ending inventory and understating cost of sales

Define corporate governance, the board of directors, and the audit committee and explain how they relate to each other.

Corporate governance- all the people, processes, & activities in place to help ensure proper stewardship over an entity's assets Board of Directors- the body primarily responsible for management oversight in corporations Audit committee- oversees internal & external audit work done for an entity Board of directors controls corporate governance. The audit committee is made up of members from the board of directors

Inventory can be observed as it is _____ by client personnel

Counted

Which of the following best describes the general character of the three generally accepted auditing standards classified as standards of field work?

Criteria for audit planning and evidence gathering

Current files vs Permanent file

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

The audit objective that all transactions are recorded in the proper period is related most closely to which of the Audit Standards Board (ASB) transaction assertions?

Cutoff

The engagement partner and manager review the work of engagement team members to evaluate which of the following? A.) The work was performed and documented. B.) The objectives of the procedures were achieved. C.) The results of the work support the conclusions reached. D.) All of these are correct.

D.) All of these are correct.

Successor auditors need to communicate with predecessor auditors __________ accepting the engagement. A.) subsequent to B.) immediately following C.) concurrent with D.) before E.) after

D.) Before

Shopping for accounting principles is __________ by Sarbanes-Oxley. A.) forbidden B.) explained C.) required D.) discouraged E.) encouraged

D.) Discouraged

A written understanding between the auditor and the entity concerning the auditor's responsibility for fraud is usually set forth in a(n) A.) management letter. B.) letter of audit inquiry. C.) internal control letter. D.) engagement letter.

D.) Engagement letter.

Substantive Procedures

Designed to detect material misstatement of relevant assurtions

Substantive Procedures

Detect material misstatements in a transaction class, account balance, and disclosure component of the financial statements. Looking at transactions & tracing them to financial statements then confirm material amounts on accounts

The risk that an auditor's procedures will lead to a conclusion that material misstatement in an account balance does not exist, when in fact misstatement does exist, is known as

Detection risk

Which of the following is the essential purpose of the audit function?

Determination of whether the client's financial statement assertions are fairly stated

Which of the following best describes the reason why an independent auditor is often retained to report on financial statements?

Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements.

You are a new staff auditor and you are auditing a client's inventory account. Briefly describe one way you might obtain direct evidence and one way you might obtain indirect evidence that the inventory account balance is fairly stated.

Direct- count physical inventory & match against inventory account Indirect- examine invoices from suppliers

Tests of Controls

Directed toward the evaluation of the effectiveness of the design and operation of internal controls.

Industry averages available through

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

__________ must ask management to authorize the predecessor auditors to discuss confidential information. A.) Attorneys B.) IRS agents C.) Clients D.) CPAs E.) Successor auditors

E.) Successor Auditors

Analytical Procedures

Evaluations of financial information through analysis of plausible relationships among financial and non-financial data Trends & ratios

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

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

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

Existence or occurrence

The audit objective that all the transactions and accounts presented in the financial statements represent real assets, liabilities, revenues, and expenses is related most closely to which of the PCAOB assertions?

Existence or occurrence

When an auditor reviews additions to the equipment (fixed asset) account to make sure that repair and maintenance expenses are not understated, she wants to obtain evidence as to management's assertion regarding

Existence.

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

Existing

Which of the following best describes the primary role and responsibility of independent external auditor?

Express an opinion on the fairness of a company's annual financial statements and footnotes.

Which of the following would be considered a nonattest assurance service engagement? 1. Expressing an opinion about the reliability of an entity's financial statements. 2. Reviewing and commenting on an entity-prepared business plan.

Expressing an opinion about the reliability of an entity's financial statements.

Internal or external: Bank statements

External

Internal or external: Long-term debt agreements

External

Internal or external: Remittance advices

External

Internal or external: Vendors' invoices

External

__________ are required to be public accountants.

External auditors

Independent-Audit Financial Statements

Financial Statement Auditors

Pick the type of work this auditor performs.

Financial Statement Auditors: Independent-Audit Financial Statements Internal Auditors: Audit the company they work for Governmental Auditors: Report to Congress or Municipal Governments IRS Auditors: Enforce Federal tax laws only

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

Financial statement accounting records worksheets

Which of the following statements relating to attest and assurance services is not correct?

Financial statement auditing is a form of attest service but it is not an assurance service.

As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to

Find small errors

Which of the following is correct concerning required auditor communications about fraud?

Fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved

The suitable criteria in a financial statement audit are set forth in the financial reporting framework selected by management, often _______.

GAAP

Attestation standards to its correct type (general/standards of fieldwork/standards of reporting).

General: Practitioner must have adequate technical training and attest function proficiency, Practitioner must have adequate knowledge in subject matter, Subject matter of engagement must be able to be evaluated Fieldwork: Adequate planning, assistance, and supervision is required Reporting: The report must identify the subject matter and character of the audit, The report must state the conclusion of the practitioner

Attestation standards to its correct type (general/standards of fieldwork/standards of reporting).

General: Subject matter is capable of measurement against criteria, Practitioner shall have adequate knowledge in subject matter Fieldwork: Work shall be adequately planned and supervised Reporting: Subject matter shall be identified, Report shall state conclusion is based on criteria of matter measured

Report to Congress or Municipal Governments

Governmental Auditors

Enforce Federal Tax Laws Only

IRS Auditors

__________ perform compliance audits of income tax returns of individuals and corporations to determine that income has been computed and taxes are paid as required.

IRS auditors

__________ perform compliance audits of income tax returns of individuals and corporations to determine that income has been computed and taxes paid as required.

IRS auditors

Engagement partner and other supervisory members of the team:

Inform engagement team members of their responsibilities Direct engagement team members to identify and communicate audit issues Review the work of the engagement team members

What is the term used to identify the risk that the client's financial statements may be materially false and misleading?

Information risk

When is it a duty to disclose fraud to parties other than the client's senior management and its audit committee most likely to exist?

In response to inquiries from a successor auditor

Rule 102

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

__________ risk is the risk of material misstatement of an assertion without considering internal control.

Inherent

Which of the following best places the events of the last decade in proper sequence?

Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB.

Risk of material misstatement refers to a combination of which two "client" components of the audit risk model?

Inherent risk and control risk

Level 1

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

List Tests of Controls (5)

Inquiry Observation Inspection Walkthrough Reperformance

Internal or external: Duplicate copies of sales invoices

Internal

Internal or external: Materials requisition forms

Internal

Internal or external: Overhead cost allocation sheets

Internal

Internal or external: Payroll checks

Internal

Internal or external: Purchase orders

Internal

Internal or external: Shipping documents

Internal

Audit the Company They Work For

Internal Auditors

__________ are the only auditors that work for the company that they are auditing.

Internal auditors

__________ are the only auditors who work for the company that they are auditing.

Internal auditors

Describe the relationship between internal controls, individual transactions, & account balances

Internal controls are used to help prevent misstatements when recording transactions. Transactions are reported into accounts which have a balance (total) of all the transactions. Account balances are used to prepare the financial statements.

Analytical procedures are the primary way to test data _____.

Interrelationships

Which of the following is not a PCAOB assertion about inventory related to presentation and disclosure?

Inventory is properly stated at its cost on the balance sheet.

Which of the following statements best describes what is meant by an unqualified audit opinion?

Issuance of a standard unqualified auditor's report indicates that in the auditor's opinion the client's financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases.

Why must an auditor assess materiality?

It is not logical to test all transactions & accounts. It would be too time consuming & costly. An auditor focuses on misstatements that have high materiality meaning that they would affect the users decidions

Client upgraded accounting system, Which of the following best describes the main affect of this event on the audit risk model for the current year?

It will likely decrease the risk of material misstatement

Responsibilities

Members should exercise sensitive professional and moral judgments in all their activities

2. Compare R&D costs to budget

Misclassification of R&D expenses

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

Letter

If acceptable audit risk is set at low and assessed risk of material misstatement is high, then detection risk must be

Low

__________ is (are) responsible for the financial statements.

Management

Which of the following statements best describes management's and the external auditor's respective levels of responsibility for a public company's financial statements?

Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatement.

Which of the following would be classified as an error?

Misinterpretation by management of facts that existed when the financial statements were prepared

5. Compare production records to units to sales

Misstatement of Sales and Inventory

1. Comparison of inventory levels for this year and last

Misstatement of inventory Inventory Obsolescence

Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements?

Management places substantial emphasis on meeting earnings projections

Determine Materiality (qualitative)

Material misstatements in prior years. High risk of fraud. Potential loan covenant violations. High market pressures. Volatile business environment. Higher than normal risk of bankruptcy.

Which of the following concepts are pervasive in the application of GAAS, particularly the standards of fieldwork and reporting?

Materiality and audit risk

Define misstatements arising from fraudulent financial reporting and misstatements arising from misappropriation of assets in one sentence each.

Misstatements arising from fraudulent financial reporting are intentional misstatements or omissions of amounts or disclosures in financial statements intended to deceive financial statement users. Misstatements arising from misappropriation of assets involve the theft of an entity's assets where the theft causes the financial statements to be misstated.

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

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

Document overall audit strategy and audit plan, which involves documenting the decisions about:

Nature Timing Extent

Disclaimer

No opinion is expressed; insufficient appropriate evidence to form an opinion on FS or lack of independence

Combined tolerable misstatement is generally greater than planning materiality because:

Not all accounts will be misstated by their full tolerable misstatement allocation. Audits of individual accounts are conducted simultaneously. Materiality is often a small fraction of the account being audited and planned procedures will be sufficiently precise to identify significant misstatements. When errors are identified, additional testing is typically performed in that account and related accounts. Overall materiality serves as a "safety net."

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

Numbered

Internal Audit Function

Objectivity- extent to which the IAF's status & policies & procedures support the objectivity of internal auditors Competence- level of competence of the IAF Systematic- application of IAF of a systematic & disciplined approach including quality control

When auditing an investment in another company, an auditor most likely would seek to conduct which audit procedure to help satisfy the valuation assertion?

Obtain market quotations from The Wall Street Journal or another independent source.

The existance of audit risk is recognized by the statement in the auditor's standard report that the auditor

Obtains reasonable assurance about whether the financial statements are free of material misstatement

Assertions about Presentations and Disclosures

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

Which of the following factors is least likely to represent an opportunity to commit fraud?

Operating losses make a hostile takeover imminent

Determine Materiality (quantitative)

Percentage of: Income (loss) before taxes. Income from continuing operations. Three year average income. Total assets. Net assets. Total revenues. Gross profit. Total equity

Which of the following is not included in the American Accounting Association (AAA) definition of auditing?

Potential conflict of interest

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

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

In an attestation engagement, a CPA practitioner is engaged to

Prepare a written report containing a conclusion about the reliability of a management assertion.

Code of Conduct (3)

Principles Rules of Conduct Interpretations of the Rules

Which professional and regulatory bodies establish the ethical and professional rules for auditors of public companies? private companies?

Private- AICPA & ISB Public- PCAOB, SEC & ISB

Which of the following is not a part of the role of internal auditors?

Providing reports on the reliability of financial statements to investors and creditors.

A client has used an inappropriate method of accounting for its pension liability on the balance sheet. The resulting misstatement is material, but the auditor does not consider its effect to be pervasive. The auditor is unable to convince the client to alter its accounting treatment. The rest of the financial statements are fairly stated in the auditor's opinion. Which kind of audit report would an auditor most likely issue under these circumstances?

Qualified opinion due to departure from GAAP.

Re-performance Example

Re performing aging of accounts receivable on your own

Rule 202

Requires that members of the AICPA comply with professional standards when performing professional services, whether or not they are practicing in public accounting.

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

Revenue

How to Identify Related Parties

Review board minutes. Review conflict-of-interest statements. Financial and reporting information provided to creditors, investors, and regulators. Contracts or other agreements with major customers, vendors, and management. Review significant unusual transactions.

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

Rights and obligations

The audit objective that all balances include items owned by the client is related most closely to which one of the ASB balance assertions?

Rights and obligations

__________ assessment procedures are performed when obtaining an understanding of the client.

Risk

You are the senior on an audit of Two Be Gone, a large publicly held company. The company recently completed an acquisition of its fifth largest competitor. What risks might this present? How will you, the auditor, respond to these risks (i.e. what actions should you take)?

Risks??? After identifying possible risks, the auditor should determine which ones may result in material misstatements in the financial statements & evaluate these risks

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

Smaller

Auditors may use audit ____ to test clerical accuracy.

Sowftware

______ may be involved in some testing of calculations.

Specialists

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

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

Additional Value-added Services

Tax planning Risk Assessment Benchmarking Electronic Commerce Internal Reporting System Design & Integration Auditors who audit public companies are limited in the types of consulting services that they can offer their auditees. NEVER MAKE MANAGEMENT DECISIONS ONLY ADVICE

Example of Inspection

Test of controls to inspect records for proper authorization

Substantive Test

Tests for errors & fraud

Tests of Detail

Tests for errors or fraud in individual transactions, account balances, and disclosures

2 Substantive Procedures

Tests of Details Analytical Procedures

Dual-Purpose Tests

Tests of controls Substantive tests of transactions *PCAOB does not like this

Tolerable Misstatement

The amount of planning materiality allocated to an account or class of transactions

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

The balance sheet

With respect to an entity's financial statements, describe both the responsibility of management and of the auditor.

The financial statements are the responsibility of management. The auditor's responsibility is to express an opinion on the financial statements based on the audit.

Which of the following statements is false as it relates to the auditors responsibility to document its risk assessment?

The level of risk must be set quantitatively

Which of the following statements best describes the role of materiality in a financial statement audit?

The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.

Which of the following best describes the main reason independent auditors report on management's financial statements?

The management that prepares the statements and the persons who use the statements may have conflicting interests.

Which of the following factors would an auditor least likely consider when assessing the inherent risk associated with sales transactions?

The nature of the credit authorization process

Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions?

To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly executed, captured, and processed.

For what primary purpose does the auditor obtain an understanding of the entity and its environment?

To plan the audit and determine the nature, timing, and extent of audit procedures to be performed.

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

b. Refundable income taxes

Information or circumstances that may indicate an illegal act

Unauthorized transactions Large payments to unspecified events Failure to file tax returns An investigation by a government entity

The audit objective that footnotes in the financial statements should be clear and expressed such that the information is easily conveyed to the readers of the financial statements is related most closely with which of the ASB presentation and disclosure assertions?

Understandability

Which of the following is the most important reason for an auditor to gain an understanding of an audit client's system of internal control over financial reporting?

Understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.

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

Understatement of liabilities Misstatement of interest expense

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

Valuation or allocation

Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required?

Whether management has any knowledge of fraud that has been perpetrated on or within the entity

Which of the following questions would be inappropriate for an auditor to ask a client when exhibiting an appropriate level of professional skepticism while completing an audit procedure related to the internal control system?

Which of your employees is a fraudster?

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

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

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

a. Accounting records to the supporting documents

For each of the following situations, indicate what type of audit report is most appropriate. a. The auditor lacks independence in fact, but not necessarily in appearance b. There is a scope limitation and it is material but the overall financial statements are still presented fairly. c. The uncorrected misstatements are immaterial d. There is a departure from GAAP and it is pervasively material

a. Disclaimer b. Qualified c. Unqualified d. Adverse

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

a. Lead schedule

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

a. The audit report

working papers demonstrate ____________ of audit team for work performed

accountability

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

accounting complex/unusual estimates results procedures report performed and reviewed

A(n) _______ provides the highest form of assurance CPAs can offer.

audit

In a(n) _______, the risk of material misstatement is low.

audit

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

b. Analytical procedures

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

b. I/S

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

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

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

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

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

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

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

balances date

Examples of working papers

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

Why is ratio a richer form of analysis than trend analysis

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

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

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

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

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

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

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

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

c. The examination of changes in an account over time

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

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

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

c. rights and obligations

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

change transactions

Cross- sectional analysis

compare ratios of similar firms at the same point in time

An auditor selected items for test counts from the client's warehouse during the physical inventory observation. The auditor then traced these test counts into the detailed inventory listing that ultimately agreed to the financial statements. This procedure most likely provided evidence concerning management's assertion of

completeness.

Cutoff tests designed to detect credit sales made before the end of the year that have been recorded in the subsequent year provide assurance about the PCAOB assertion of

completeness.

1. A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.

control risk

4. Disbursements have occurred without proper approval.

control risk

5. There is inadequate segregation of duties.

control risk

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

d. A copy of the FS

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

d. Computations made by the auditor

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

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

Representation letters are dated as? are signed by?

date of the auditors report Client CFO AND CEO

Quality control procedures exist to provide reasonable assurance that the firm follows professional standards on __________ engagement(s).

every

The auditing standards that are used to guide the conduct of the audit are...

explicitly referred to in the scope paragraph of the auditor's standard report.

In performing an attestation engagement, a CPA typically

expresses a conclusion on an assertion about some type of subject matter.

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

fair liability

An opinion indicates that the financial statements are presented __________.

fairly

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

general ledger accounts. Working trial balance

Headed by the Auditor General, the work of __________ includes compliance, operational, and financial audits.

governmental auditors

Lead schedule a.k.a

grouping sheet or summary schedules

If risk of material misstatement is higher than originally anticipated, the auditor may respond by

increasing supervision

The probability that the information circulated by a company will be false or misleading is referred to as

information risk.

Two types of material misstatement risk

inherent control

Risk that exists without audit

inherent and control

10. XYZ Company, a client, lacks sufficient working capital to continue operations.

inherent risk

2. Cash is more susceptible to theft than an Inventory of coal.

inherent risk

7. Notes receivable are susceptible to material misstatement, assuming there are no related internal control

inherent risk

9. The client is very close to violating debt covenants.

inherent risk

Technological developments make a major product obsolete.

inherent risk

The PCAOB has adopted the AICPA standards as its __________ quality control standards.

interim

Most large corporations typically have a large group of __________.

internal auditors

The Public Company Accounting Oversight Board...

is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.

An independent audit adds value to the communication of financial information because the audit...

lends credibility to the financial statements

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

material misstatement

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

matters of continuing significance for future audits

Risk Assessment Procedures are used to

obtain an understanding of the entity and its environment, including its internal control.

Risk Assessment Procedures

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

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

profession judgement precision auditor

Because of the risk of material misstatement, an audit of financial statements in accordance with generally accepted auditing standards should be planned and performed with an attitude of

professional skepticism.

Assurance services involve all of the following, except

providing absolute rather than reasonable assurance.

QC standards help to ensure that CPA firms meet their responsibilities to their clients and the __________.

public

Appropriate is the measure of the

quality of the audit evidence

Sufficient is a measure of the

quantity of audit evidence that should be obtained

The final step of an audit is issuing the audit __________.

report

A(n) _______ is generally limited to inquiry and analytical procedures.

review

A(n) _______ report includes the wording that "we are not aware of any material modifications...".

review

analytical procedures at the end of audit include

reviewing FS and recomputing ratios to find any undetected or unusual

horizontal analysis

reviewing clients ratios and trends over time

Analytical Example

scanning payroll register for unusual payments

The process of a CPA obtaining a certificate and license in a state other than the state in which the CPA's certificate was originally obtained is referred to as

substantial equivalency.

Statement of Quality Standards identify __________ elements of quality control.

six

Audit risk

the risk that the auditors expresses an inappropriate audit opinion when the financial statements are materially misstated; auditor only provides reasonable assurance

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

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

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

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

Test of classes of transactions address whether particular...

types of transactions have been properly accounted for

Observation example

watching client count inventory watching mailroom clerks

The underlying conditions that create demand by users for reliable information include all of the following, except

users lack professional skepticism.

Regression analysis - what is the advantage of using

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

Inquiries of warehouse personnel concerning possible obsolete or slow moving inventory items provide assurance about the PCAOB assertion of

valuation.

cold review or quality review is...

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

Discuss an overview of the financial statement audit process using the terms "assertion," "evidence," and "report."

"evidence," and "report." The auditor gathers evidence about the business transactions that have occurred (economic activity and events) and about management (the preparer of the statements). The auditor uses this evidence to compare the assertions contained in the financial statements to the criteria chosen by the user. The auditor's report communicates to the user the degree of correspondence between the assertions and the criteria.

When can a CPA disclose confidential information without the client's consent?

(1) to meet disclosure requirements for GAAP or GAAS (2) to comply with a valid subpoena (3) as required by an authorized peer review body (4) investigative or disciplinary proceeding (5) in connection with the purchase, sale, or merger of the practice.

Name and discuss the seven phases of the audit process.

1. Client acceptance/continuance and establish an understanding with the client 2. Preliminary engagement activities: Preliminary engagement activities include (1) determining the audit engagement team requirements and (2) ensuring the independence of the audit team and audit firm. 3. Plan the audit: The audit team must make a preliminary assessment of materiality and relevant risks. Then prepares a written audit plan that sets forth, in reasonable detail, the nature, extent, and timing of the audit work. 4. Consider and audit internal control: The auditor gains an understanding of internal control. 5. Audit business processes and related accounts: The auditor determines and performs individual audit procedures directed toward specific assertions in the account balance that are likely to be misstated. 6. Complete the audit: The auditor evaluates the sufficiency of the evidence gathered, assesses the possibility of contingent liabilities, and searches for any events subsequent to the balance sheet date that may impact the financial statements. 7. Evaluate results and issue the report: The auditor reaches a conclusion. Issues an report.

Engagement Letter includes:

1. Objectives of the engagement 2. Management's responsibilities 3. Auditor's responsibilities 4. Limitations of the engagement MAY INCLUDE: 1. Specialist use arrangements 2. Additional services

When to use explanatory paragraph?

1. Reference to report on audit of ICFR 2. Going conern 3. Lack of consistency 4. Additional emphasis

Discuss the conditions that prohibit the auditor from issuing an unqualified opinion and the types of reports that the auditor may issue for a financial statement audit.

1. Scope limitation. A scope limitation results from an inability to collect sufficient appropriate evidence, such as when management prevents the auditor from conducting an audit procedure considered necessary. *QUALIFIED REPORT 2. Departure from GAAP. The financial statements are affected by a departure from GAAP. *ADVERSE REPORT 3. Lack of auditor independence. The auditor must comply with the second general standard and the Code of Professional Conduct in order to issue an unqualified opinion. *DISCLAIMER REPORT

Discuss how evidence regarding internal controls, individual transactions, & account balances can help an auditor determine if the financial statements are fairly stated.

35

Direct Relationship

A financial interest that is owned directly by an individual or entity, or is under the control of an individual or entity

Rule 301

A member in public practice shall not disclose any confidential client information without the specific consent of the client.

Rule 502

A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, over-reaching, or harassing conduct is prohibited.

Scope & nature of services

A member in public practice should observe the Principles of the Code of Professional Conduct in determining the type and extent of services to be provided

Rule 505

A member may practice public accounting only in a form of organization permitted by law or regulation whose characteristics conform to resolutions of Council. A member shall not practice public accounting under a firm name that is misleading. Names of one or more past partners may be included in the firm name of a successor organization. A firm may not designate itself as "Members of the American Institute of Certified Public Accountants" unless all of its CPA owners are members of the Institute.

Rule 201

A member shall comply with the following standards and with any interpretations thereof by bodies designated by Council. Professional Competence Planning & Supervision Due Professional Care Sufficient Relevant Data

Rule 302

A member shall not  (1) Perform for a contingent fee any professional service for, or receive such a fee from, a client for whom the member or the member's firm performs (a) an audit or review of a financial statement, (b) a compilation of a financial statement expected to be used by a third party if the compilation report does not disclose a lack of independence, or (c) an examination of prospective financial information, or (2) Prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.

Rule 203

A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with GAAP or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with GAAP, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole.

Rule 501

A member shall not commit an act discreditable to the profession.

Objectivity & independence

A member should be free of conflicts of interest in discharging professional responsibilities

Due care

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

Jeff Johns is a staff accountant and has been assigned to the audit of Worldwide Enterprises, Inc. Subsequent to the completion of fieldwork Jeff was assigned to draft the audit report. The content of one of the paragraphs he has drafted reads as follows: As explained in Note 2 to the financial statements, Worldwide Enterprises has charged goodwill and certain other intangible assets acquired in two separate acquisitions directly to shareholders' equity. Under generally accepted accounting principles, these intangibles should have been recorded as assets and amortized to income over future periods. Had these intangibles been capitalized, total assets would have increased by $400,000 as of December 31, 2009 and net income and earnings per share would be increased by $380,000 and $2.25, respectively (assuming a 20-year amortization period). a. Based on the contents of the paragraph above, which condition requiring a departure from a standard unqualified opinion exists in the engagement? b. Assuming that the engagement partner agrees with the paragraph Jeff has prepared above, where in the auditor's report should the paragraph be placed? c. How would the materiality of the condition above affect the final choice of opinion?

A. Indicates a departure from GAAP; either qualified or adverse opinion depending on the materiality B. If qualified or adverse, a paragraph should be placed before the opinion paragraph C. A material misstatements needs a qualified opinion. A pervasively material misstatements needs an adverse opinion.

You are a new employee at the accounting firm Murray & Murray, CPAs. Before you are assigned to your first audit, your supervisor tests your knowledge and asks you to explain the term "scope" in the context of a financial statement audit. Required: A. Provide a definition of scope. B. Describe what influences an auditor's determination of scope.

A. Scope is the type & amount of audit work that is to be done B. risk, materiality, & evidence influence scope

DATRIX, Inc, a Fortune 500 company, has been experiencing poor performance. Industry analysts have been issuing negative reports and the company's stock price has been steadily declining. As an auditor, what would concern you about the audit engagement of DATRIX, Inc.

An auditor should be concerned because of the apparent incentive the management of DATRIX may have to commit financial statement fraud. For instance, the company's management may be tempted to change accounting estimates or use other means to falsely increase the company's book profits. The auditor should exercise professional skepticism in this engagement and addresses carefully the risk of financial statement fraud.

Explain the relationship between audit, attest and assurance services.

Audit- form of attest services; objectively obtaining & evaluating evidence regarding assertions about economic actions & events to ascertain the degree of correspondence between those assertions & established criteria & communicating the results to interested users Attestation- practitioner is engaged to issue a report on subject matter or an assertion about subject matter that is the responsibility of another party Assurance- independent professional services that improve the quality of information or its context for decision makers All need evidence to give information

Your classmate asserts, "Accountants shouldn't need to take business courses besides accounting, because they are only interested in the financial statements of a company." Defend or refute this statement.

Auditors need to develop a deep understanding of business. Most business concepts and risks have the potential to affect the financial statements either immediately or in the long run Increases the likelihood of identifying material misstatements in the financial statements

Changes affecting consistency

Change in accounting principle Change in reporting entity Correction of a misstatement in FS NOT: Change in accounting estimate Change expected to have material future effect Change in classification & reclassification

Ethics & Professionalism

Ethics- a system or code of conduct based on moral duties & obligations that indicate how we should behave Professionalism- the conduct, aims, or qualities that characterize a profession or professional person

Continuing Client Retension

Evaluate client retention periodically near audit completion or after a significant event 1. Conflict over accounting & auditing issues 2. Dispute over fees

Attest engagement

Examples include financial statement audits, reviews, and examinations of prospective financial information.

Assertions about account balances at the period end:

Existence- assets, liabilities, & equity interests exist Rights & obligations- entity holds or controls assets & liabilities are obligations of the entity Completeness Valuation & allocation- amounts adjusted appropriately

Name two account balance management assertions pertaining to inventory and explain why they are considered in an audit.

Existence: physical examination tests can be done;sometimes inventory is overstated Completeness: inventory may not include everything that should have been recorded

Mike has just graduated from State University with a bachelor's degree in accounting. He would like to pursue a career in auditing. What options does Mike have? Describe three auditing career options, including a description of the organization Mike would work for.

External: work for a CPA firm providing independent audits to nonpublic or public companies; need to pass the Uniform CPA Exam Internal: directly employed by the entity on which he is performing audits. Governmental: This is essentially a form of internal auditing and Mike could be employed by federal (such as the Government Accountability Office or the Internal Revenue Service), state, or local agencies. Forensic: fraud

Business Processes (5)

Financial Purchasing Human Resource Management Inventory Management Revenue

There are several types of audit services that are provided by auditors. Identify and define three of these types of audits.

Financial Statement Audit: Auditors test the transactions, balances, and disclosures in a set of financial statements to determine if they are materially correct. Internal Control Audit: Auditors test the internal controls of a company to determine whether the control system is functioning effectively (i.e. preventing, detecting, and correcting misstatements in the financial statements). Forensic Audit: Auditors conduct forensic audits to detect or deter fraudulent activities.

Engagement Letter

Formalizes the arrangement reached between the auditor and the client.

Standards of Reporting

GAAP Consistency- across perios Disclosures Opinion

GAAS 3 main parts

General Field Work Reporting

During the course of the audit of FF Financial, you find that some accounting entries have been altered. You believe this may be the result of management fraud and you have determined that the effect of this could be material to the financial statements. What are appropriate steps to take?

In this situation, the auditor should attempt to obtain audit evidence to determine whether material fraud has occurred and, if so, its effect. If fraud is found in one account, there are chances the auditor will find fraud in other accounts, as well. The auditor needs to discuss the matter and the approach to further investigation with an appropriate level of management that is at least one level above those involved in committing the fraud and with senior managements.

Sally Thompson's company, Sally's Shoes, is a successful shoe retail store with one store. Sally would like to expand to two locations, but the bank has asked for an independent audit before it will provide financing. Sally hires her brother-in-law, George Thompson, to perform the audit. George has experience in auditing non-profit organizations and he decides to perform the audit the same way as his other audits. After completing all the steps of the audit process, George issues an unqualified opinion indicating that he is certain that the company's financial statements contain no misstatements. Comment on any potential problems with George's audit of Sally's Shoes.

Independence: brother in law; biased Competence: only has good experience in non-profit; needs an understanding of the industry; audit should not be performed the same as the other He cannot be certain because an unqualified report just gives assurance to material misstatements

Ms. Lembke is a partner for DTS, a CPA firm. She is the lead partner for the firm's largest client, The Grey Elephant. Ms. Zadina, who works in the same office as Ms. Lembke, has a sister who is the controller for The Grey Elephant. Because of potential independence issues, Ms. Zadina does no work for The Grey Elephant. Ms. Zadina is being considered for promotion to partner. What independence issues should Ms. Lembke consider before promoting Ms. Zadina?

Interpretation 101-1 of the AICPA Rules of Conduct states that all partners of a firm must be independent of any attestation clients of the firm. Therefore, if Ms. Zadina is promoted to partner, DTS would no longer be able to provide attestation services for The Grey Elephant. If Ms. Zadina is promoted, she will have to move to another office or DTS will have to give up their largest client.

Jane Goodperson performed an audit on the Quagmire Corporation and issued an unqualified opinion. Jane performed the audit with due professional care and in accordance with generally accepted auditing standards. Two months after the report is issued, Jane discovers on the news that the CEO of Quagmire, Johnny Best had been stealing small amounts of inventory. The amount, however, is immaterial compared to the overall inventory of the corporation. Jane soon receives a call from Quagmire's CFO, Mark Beastly. Mark wants Jane to refund her audit fees. Mark thinks Jane did not properly perform the audit, as she did not discover this fraud. Further, he feels that now Quagmire's financial statements are not fairly stated because of Jane. How should Jane respond to this claim?

Jane should tell Mark that her responsibility was to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud. She had no responsibility to plan and perform the audit to obtain reasonable assurance that misstatements, whether caused by errors or fraud that are not material to the financial statements will be detected. Quagmire's management, not Jane, has responsibility for the financial statements. In fact, because of the Sarbanes-Oxley Act of 2002, Mark had to take explicit responsibility for the financial statements by "certifying" that he as CFO is responsible for establishing and maintaining internal control and that the financial statements fairly present the entity's financial conditions and operations. This statement is probably still true, since the amount stolen was immaterial.

Section 301 of Sarbanes-Oxley Act requires the following for audit committee members of PUBICALY held companies: PRIVATE?

Member of board of directors and independent. Directly responsible for overseeing work of any registered public accounting firm employed by the company. Must preapprove all audit and nonaudit services provided by its auditors. Must establish procedures to follow for complaints. Must have authority to engage independent counsel. PRIVATE: none

Public interest

Members should accept the obligation to act in a way that will honor the public trust and demonstrate commitment to professionalism

Often in an audit, total combined tolerable misstatement is greater than overall materiality. Why is this the case?

Not all accounts will be misstated by the full amount of their tolerable misstatement allocation When control weaknesses or misstatements are identified in an account, the auditors typically perform additional procedures in that and related, accounts. Thus, the actual testing will often achieve a much smaller margin for misstatement than planned tolerable misstatement

Prospective Client Acceptance

Obtain and review financial information. Inquire of third parties regarding client integrity. Consider unusual business or audit risks. Determine if the firm is independent. Determine if the firm has the necessary technical skills and knowledge. Determine if acceptance violates any applicable regulatory agency requirements or the Code of Professional Conduct.

Assertions about presentations & disclosures:

Occurence & rights & obligations- disclosed events Completeness Classification & understandability- financial info is appropriately presented & disclosures clearly expressed Accuracy & valuation

Assertions about classes of transactions & events for the period under audit:

Occurrence - transactions have occurred & pertain to the industry Completeness- have been recorded Authorization Accuracy- recorded appropriately Cutoff- correct accounting period Classification- proper accounts

When to use modified wording?

Opinion based in part on the report of another auditor

Audit Teams & what they do

Partner- agreement with auditee, plan audit, assemble team Manager- ensure plan is proper, schedule team members, review audit report, collection of payments Senior- assist audit plan, budgets, assign tasks to staff, supervise staff Staff- perform audit procedures, prepare documentation for completed work

What auditing standards are used to conduct an audit for a privately-held corporation? What auditing standards are used to conduct an audit for a publicly held-and-traded corporation? What organization is responsible for setting each of these sets of standards?

Privately-held: Auditing Standards Board Public: PCAOB

Rule 503

Prohibited Commissions: A member in public practice shall not for a commission recommend or refer to a client any product or service or receive a commission, when a member or the member's firm also performs for that client (a) an audit or review of financial statements, (b) a compilation of financial statements expected to be used by a third party and the compilation report does not disclose a lack of independence, or (c) an examination of prospective financial information. Disclosure of Permitted Commissions: A member in public practice who is not prohibited by this rule from performing services for or receiving a commission and who is paid or expects to be paid a commission shall disclose that fact to any person or entity to whom the member recommends or refers a product or service to which the commission relates. Referral Fees: Any member who accepts a referral fee for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to the client.

Principles underlying an audit

Purpose- to express an opinion on FS prepared by management Responsibilities- competence & capacity; comply with ethical requirements; professional skepticism; professional judgement Performance- sufficient audit evidence supporting reasonable assurance Reporting- express an opinion based on the evidence evaluated

Standard Unmodified Report List 9 Elements Used when?

Report Title Addressee Introductory paragraph Management's responsibility Auditor's responsibility Scope paragraph Opinion paragraph Name of auditor Audit report date When the auditor has gathered sufficient evidence, the audit has been performed in accordance with GAAS, and the financial statements conform to GAAP

Standard Unqualified Report List 8 Elements Used when?

Report Title Addressee Introductory paragraph Scope paragraph Opinion paragraph Explanatory paragraph Name of auditor Audit report date When the auditor has gathered sufficient evidence, the audit has been performed in accordance with PCAOB standards, and the financial statements conform to GAAP

Principles of professional conduct

Responsibilities The public interest Integrity Objectivity & independence Due car Scope & nature of services

Material Indirect Relationship

Results when a covered member has a financial interest in an entity that is associated with an attest entity, for example an investment in a mutual fund that owns the entity's stock

List the organizations involved in standard setting for auditors

Securities & Exchange Commission (SEC) Financial Accounting Standards Board (FASB) International Auditing & Assurance Standards Board (IAASB) Public Company Accounting Oversight Board (PCAOB) American Institute of Certified Pubic Accountants (AICPA) Institutional Accounting Standards Board (IASB)

Disciplinary Actions (PEEC) trial board actions

Termination of AICPA Membership Suspend AICPA Membership

A standard, unqualified auditor's report contains three paragraphs, plus a fourth explanatory paragraph in some circumstances. Provide a brief (one sentence) description for each paragraph.

The introductory paragraph indicates which financial statements are covered by the report, that the statements are the responsibility of management, and that the auditor has a responsibility to express an opinion. The scope paragraph tells what an audit entails and how the audit was conducted The opinion paragraph indicates the auditor's opinion as to whether the financial statements are fairly presented in accordance with the criteria against which they were audited, GAAP. An explanatory paragraph is used to bring matters of importance to the reader's attention.

Explain the relationship between sample size, materiality and desired level of assurance.

The size of a sample is influenced by the materiality and the desired level of assurance for the account or assertion being examined. There is an inverse relationship between sample size and materiality and a direct relationship between sample size and the desired level of assurance

Integrity

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

Why do we assess business risks?

To understand the entity's business & transactions To identify financial statement accounts likely to contain errors The auditor can allocate more resources to investigate more risky accounts

Audit Report 3 types

Unqualified- clean audit report; financial statements are free of material misstatements, auditor does not find it necessary to qualify opinion about the fairness of the financial statements Qualified- financial statements are fairly stated except for the misstatements identified by the auditor; misstatement is considered material & management refuses to correct it Adverse- the financial statements are not fairly stated & should not be relied upon; when misstatements are so material that it affects the interpretation of the financial statements

Why do professions establish codes of conduct that define ethical behaviors for members of the profession?

Users know what to expect Behavior acceptable Use rules to monitor actions

Distinguish between the following theories of ethical behavior: utilitarianism, a rights-based approach and a justice-based approach.

Utilitarianism- recognizes that decision making involves traded-offs between the benefits & burdens of alternative actions & focuses on consequences & on individuals affected Rights-based approach- assumes that individuals have certain rights & other individuals have a duty to respect those rights when making decisions Justice-based approach- in concerned with issues such as equity, fairness, & impartiality

The following four situations require a modification to the standard unqualified audit report. Identify the modification required for each. a. Opinion based in part on the report of another auditor b. Going concern c. Lack of consistency d. Emphasis of a matter

a. This situation results in a modification of the wording for the three paragraphs included in the standard report b. This situation results in an explanatory paragraph found after the opinion paragraph c. This situation results in an explanatory paragraph found after the opinion paragraph d. This situation results in an explanatory paragraph found after the opinion paragraph