Auditing - Ch 7, 8, & 11 Review Checkpoints
11.4 What additional issues are involved with miscellaneous, other, and clearing accounts?
"Miscellaneous," "other," and "clearing" accounts may represent adjustments made by the client to meet analysts' earnings expectations (or earnings management).
8.15 How would substantive procedures for accounts payable be affected by (a) a low risk of material misstatement or (b) a high risk of material misstatement?
(a) A low risk of material misstatement would normally result in a strategy by which the auditor relies on controls and reduces substantive tests. First, the auditor would confirm the low control risk evaluation by testing controls for effectiveness. More reliance would also be placed on analytical procedures. (b) High risk of material misstatement would result in a more substantive approach with little control testing.
11.18 Describe the audit documentation review process in a public accounting firm.
1. Upon completion, the audit documentation is reviewed by an audit supervisor and, sometimes, audit manager. The purpose of this review is to ensure that all appropriate steps in the audit program were performed, the referencing among audit documentation is clear, and the explanations contained in the audit documentation are understandable. 2. Once this initial review has been completed, the audit manager and audit partner review the audit documentation to ensure that the overall scope of the audit is appropriate and determine whether the overall conclusions in the audit documentation are sufficient to provide support for the opinion on the financial statements. 3. Finally, the audit documentation is reviewed by a partner who has not been involved with the audit (known as a reviewing partner). The purpose of this review is to ensure that the quality of audit work and reporting is consistent with the firm's quality standards.
8.1 What is a voucher? What is a voucher package?
A voucher is a package of documents, usually with a cover page. (The package can be a small envelope.) The voucher package contains supporting documents for a transaction. For example, a purchase voucher usually contains a purchase requisition, purchase order, receiving report, vendor invoice, and a negotiable check (check copy when the vendor invoice has been paid). Required approvals and signatures are on the documents. The voucher presents evidence of the documentation and control over a transaction. Computerized systems may have all this documentation in memory. In a voucher system, each voucher is "payable" and the detail of the payables is the vouchers themselves. At any time, the company may owe a single vendor more than one invoice represented on several vouchers. In a voucher system, there is no balance payable to each vendor—just a file of different vouchers payable.
7.3 What controls should be implemented to safeguard accounts receivable files?
Access to computer terminals should be restricted so that only authorized persons can enter or change transaction data. Access to master files is important because changes in them affect automatic computer controls, such as credit checking and accurate inventory pricing.
7.6 What makes an account significant or an assertion relevant?
According to the professional standards, an account is significant and a financial statement assertion is relevant if it has a "reasonable possibility of containing a misstatement that would cause the financial statements to be materially misstated."
8.25 What key control concept was missing at Argus Productions?
Argus did not have separation of duties. Different people should have authorized the copying services, approved the bills for payment, and coded them to projects. A supervisor should have been reviewing the expenses and comparing them to the budget.
7.21 What analytical procedures might be informative regarding the existence assertion?
Comparison of sales and accounts receivable to previous periods provides information about existence. Other useful analytical procedures include receivables turnover and days of sales in receivables, aging, gross margin ratio, and sales/asset ratios, which can be compared to historical data and industry statistics for evidence of overall reasonableness. Auditors may also compare sales to nonfinancial data such as units sold, number of customers, sales commissions, and so on. These comparisons can be made by product, period, geographic region, or salesperson.
7.27 What are the goals of dual-direction testing regarding an audit of the accounts receivable and cash collection system?
Dual-direction testing involves selecting samples to obtain evidence about control over completeness in one direction and control over occurrence in the other direction. The completeness direction determines whether all transactions that occurred were recorded (none omitted), and the occurrence direction determines whether recorded transactions actually occurred (were valid). An example of the completeness direction is the examination of a sample of shipping documents (from the file of all shipping documents) to determine whether invoices were prepared and recorded. An example of the occurrence direction is the examination of a sample of sales invoices (from the file representing all recorded sales) to determine whether supporting shipping documents exist to verify the fact of an actual shipment. The content of each file is compared with the other.
7.17 What types of audit procedures are typically performed in testing operating effectiveness of controls over the revenue and collection cycle?
In general, the types of procedures in tests of controls over the operating effectiveness involve vouching, tracing, observing, scanning, reperforming and recalculating.
7.7 Why do auditors focus on revenue as a significant account and the occurrence of revenue as a relevant assertion in the revenue cycle?
Occurrence of revenue is considered a significant account and relevant assertion for several reasons: · The magnitude of revenue is often substantial indicating that recorded revenues are generally material. · Management has an incentive to overstate revenues, thus the occurrence assertion is relevant. · Stakeholders focus on revenue as a performance measure, therefore the account is significant to users of the financial statements.
8.20 What columns in a client's PP&E and depreciation schedule are the most common focus of audit procedures?
The auditor is primarily concerned with current-year transactions in property, plant, and equipment accounts. Previous years require less attention because they were audited in prior years. Thus, additions, disposals, and depreciation charges warrant the most attention.
8.23 Describe the purpose and give examples of specific fraud detection procedures in the acquisition and expenditure cycle.
The auditor should begin by inquiring of the client about its knowledge of fraud or fraud risks. Analytical review procedures such as vertical and horizontal analyses can pinpoint accounts that appear to have unusual fluctuations. Examining invoices and vendor files for the red flags noted in 8.12 will help find phony billings. The purpose is to identify fraud risk, evaluate the significance of the risk, and determine the amounts of any actual fraud on the financial statements.
7.32 With reference to the case of Thank Goodness It's Friday, what contribution could an understanding of the business and the management reporting system have made to discovery of the open cash receipts journal cutoff error?
The auditors would have known about the normal Friday closing of the books for weekly management reports, and they could have been alerted to the possibility that the accounting employees overlooked the once‑a‑year occurrence of the year-end date during the week.
8.11 How should an auditor test for proper authorization in the expenditure cycle?
The best testing for proper authorization is to select a sample of received materials (select the sample form the accounts payable journal or receiving report file) and vouch the order to purchase order. The purchase order should be inspected for evidence of authorization by the appropriate purchasing agent(s)
8.9 What primary functions should be separated in the acquisition and expenditure cycle?
The functions that should be separated to maintain internal control in a purchasing system include (a) custody of the goods (receiving and stores departments), (b) authority to initiate a transaction (purchasing department), (c) bookkeeping (accounts payable department, inventory record‑keeping department), and (d) periodic physical counts (reconciliation) of inventory and fixed assets.
7.8 Why is inherent risk for the existence assertion for accounts receivable often set higher than inherent risk for the completeness assertion?
The inherent risk for the existence assertion for accounts receivable is often higher than inherent risk for the completeness assertion because management has an incentive to overstate accounts receivable. It is important to place emphasis on the existence assertion because auditors have often been sued for malpractice by providing unqualified reports on financial statements that overstated assets and revenues and understated expenses. For example, credit sales recorded too early (e.g., a fictitious sale) result in overstated accounts receivable and overstated sales revenue.
11.23 Identify the two types of subsequent events. How should information about these events be reflected in the financial statements?
The two types of subsequent events are: · Events that provided additional evidence of conditions that existed at the date of the financial statements. These subsequent events typically require adjustment to the financial statements to reflect the new information. · Events that provide evidence of conditions that arose following the date of the financial statements. These subsequent events require disclosure of the information in the financial statements or footnotes accompanying the financial statements.
8.26 What evidence could the verbal inquiry audit procedure provide in "Printing (Copying) Money"?
The verbal inquiry procedure might produce knowledge of employee's responsibilities to authorize purchases of script copies, receive them, approve payment, and code invoices to projects.
7.15 What specific control procedures (in addition to separation of duties and responsibilities) should be in place and operating in internal controls governing revenue recognition?
These specific control procedures (in addition to separation of duties and responsibilities) should be in place and operating in a control system governing revenue recognition and cash collections: · No sales order should be entered without a customer order. · A credit‑check code or manual signature should be recorded by an authorized person. · Access to inventory and the shipping area should be restricted to authorized persons. · Access to billing terminals and blank invoice forms should be restricted to authorized personnel. · Accountants should be instructed to record sales and accounts receivable when all the supporting documentation of shipment is in order, and care should be taken to record sales and receivables as of the date goods and services were shipped, and cash receipts on the date the payments are received. · Customer invoices should be compared with bills of lading and customer orders to assure that the customer is sent the goods ordered at the proper location for the proper prices and that the quantity being billed is the same as the quantity shipped · Pending order files should be reviewed in a timely manner to avoid failure to bill the customer and record shipments · Bank statements should be reconciled in detail monthly.
7.12 What are the primary control procedures to ensure completeness of recorded revenues?
To ensure completeness of recorded revenue, all invoices, shipping documents, and sales orders should be prenumbered, and the numerical sequence should be checked on a timely basis.
7.2 What purpose is served by prenumbering sales orders, shipping documents, and sales invoices?
When documents such as sales orders, shipping documents, and sales invoices are prenumbered, someone can later account for the numerical sequence and determine whether any transactions have failed to be recorded. (Completeness assertion.)
7.5 Suppose that you selected a sample of customers' accounts receivable and wanted to find supporting evidence for the entries in the accounts. Where would you go to vouch the debit entries to accounts receivable? What would you expect to find? Where would you go to vouch the credit entries? What would you expect to find?
With a sample of customer accounts receivable: · Find the support for debit entries in the sales journal file. Expect to find evidence (copy) of a sales invoice, shipping document, and customer order. The sales invoice indicates the shipping date. · Find the support for credit entries in the cash receipts journal file. Expect to find a remittance advice (entry on list), which corresponds to detail on a deposit slip, on a deposit actually in a bank statement for the day posted in the customers' accounts.
8.13 Where could an auditor look to find evidence of (a) losses on purchase commitments or (b) unrecorded liabilities to vendors?
You will find evidence about losses on purchase commitments in the open purchase order file. Evidence about unrecorded liabilities to vendors is in the (a) unmatched invoice file and (b) unmatched receiving report file.
11.25 What are auditors' responsibilities for subsequently discovered facts if these are identified (a) prior to the audit report release date and (b) following the audit report release date?
a. If subsequently discovered facts are identified prior to the audit report release date, auditors can evaluate the appropriateness of the disclosure of these events and dual date their report. b. If subsequently discovered facts are identified following the audit report release date, auditors should first assess whether (1) these facts would require revision of their report or the financial statements or (2) individuals are continuing to rely on the financial statements, If so, auditors should ensure that clients notify individuals known to be relying on the financial statements of the subsequently discovered facts and issue revised financial statements as soon as possible.
11.26 What is the purpose of dual dating the auditor's report?
Dual dating the auditor's report provides a means of inserting important information in the financial statements and footnote disclosures learned by auditors after the date of the auditor's report. A significant advantage of dual dating the report is that auditors' liability for events after the date of the auditor's report is limited to the event specifically identified in the report date.
7.18 What is dual-direction test of controls sampling in the revenue and collection cycle?
Dual direction tests of controls sampling refers to procedures that test file contents in two "directions": the occurrence direction and the completeness direction. The occurrence direction involves a sample from the account balance (e.g., sales revenue) vouched to supporting sales and shipping documents for evidence of occurrence. The completeness direction is a sample from the population that represents all sales (e.g., shipping document files) traced to the sales journal or sales account for evidence that no transactions (shipments, sales) were omitted.
8.27 If Lee had not been seen taking employees out in a limousine, how else could she have been caught?
Given Beta Magnetic's poor internal controls, it is possible that Martha would never have been caught. However, if the company ever contacted employees about their health claims, they would have revealed the fictitious charges.
11.15 Why are adjusting entries and note disclosures labeled "proposed"?
Adjusting entries and note disclosures are labeled "proposed" because it is ultimately the client's responsibility to adjust the financial statements for these items.
11.19 What is an engagement quality review?
An engagement quality review is a review of audit documentation by a partner (or equivalent with the firm) who is not involved with the audit. The purpose of this review is to ensure that the quality of the work and reporting is in keeping with the quality standards of the firm and that the evidence obtained during the audit is sufficient to support the opinion on the client's financial statements.
7.30 In the case of The Taxman Always Rings Twice, what information could have been obtained from confirmations directed to the real population of delinquent accounts?
Confirmations to taxpayers who had actually paid their taxes would have produced exceptions, complaints, and people with their counter receipts. These results would have revealed the embezzlement.
11.2 What are roll-forward procedures? Provide some examples.
Roll-forward procedures are additional procedures performed by auditors to extend the conclusions from an interim date to the date of the financial statements. Common roll-forward procedures include examining material account transactions that occur between the interim testing date and the date of the financial statements.
7.23 What are some justifications for not using confirmations of accounts receivable on a particular audit?
Justifications for the decision not to use confirmations for trade accounts receivable in a particular audit include (a) receivables are not material, (b) confirmations would be ineffective based on prior years' experience or knowledge that responses could be unreliable, and (c) analytical procedures and other substantive procedures provide sufficient, competent evidence.
8.4 Why do auditors focus on completeness of expenditures as a significant account and relevant assertion in the expenditure cycle?
Management could omit expenses and liabilities if they desired to manipulate the financial statements. Therefore management might not record, or delay the recording, of expenses and liabilities.
8.5 Why is inherent risk for the existence of inventory an issue in the expenditure cycle audit?
Management may not record or delay recording the inventory sale in order to keep inventory accounts high and cost of goods sold low.
8.14 List the management reports and computer files that can be used for audit evidence. What information in them can be useful to auditors?
Management reports that can be used for audit evidence, and information in them can be useful to auditors are as follows: · Open purchase orders: Purchase commitments, losses on purchase commitments. · Unmatched receiving reports: Goods received but not recorded as purchases or liabilities. · Unmatched vendor invoices: Unrecorded invoices that may represent unrecorded liabilities or items in dispute · Accounts payable trial balance: Subsidiary ledger of accounts payable that may show balances by vendors, indicating small balances that should be large. Invoice dates may reveal failure to record invoices late in the accounting period. · Purchases journal: Listing of all purchases available for analysis of purchasing patterns and oddities. Population for sample of purchases for tests of controls. · Fixed asset reports: Fixed assets subsidiary ledger trial balance. Scan for negative balances, capitalized repairs, and depreciation in excess of salvage value; depreciation recalculation.
8.21 What methods are used to audit other expense accounts?
Most expense accounts can be tested through analytical review procedures, substantive tests of transactions, or by testing them in conjunction with tests of related assets and liabilities (e.g., depreciation). Some expenses should be examined separately because of their unique nature (e.g., legal expenses or miscellaneous expense).
8.24 Are these specific fraud detection procedures designed to detect fraudulent financial reporting or misappropriation of assets? Explain.
Most of the procedures are designed to prevent misappropriation of assets. The expenditure cycle is an area where employees may attempt to receive payments for fictitious purchases or have the company pay for personal items run through the expenditure system as a company expense. Procedures targeted at financial statement fraud include searching for unrecorded liabilities and ensuring that expenditures are properly recorded.
11.3 How are analytical procedures used near the end of the audit?
Near the end of the audit, analytical procedures are used to (1) evaluate the adequacy of evidence gathered in response to unexpected account balance or relationships among account balances identified during the audit and (2) identify unusual or unexpected account balances or relationships among account balances that were not previously identified in earlier parts of the audit.
7.11 Why is the audit of revenue recognition riskier for a new company?
New companies often do not show a profit during their first few years. Therefore, creditors and investors often place more emphasis on the revenues, especially looking for revenue growth that might lead to future profitability. Knowing this, management could try to inflate revenues.
8.19 What assertions found in PP&E, investments, and intangibles accounts are of interest to an auditor during the examination of the expenditure and acquisition cycle?
Noncurrent assets such as property, plant, and equipment and intangibles usually pertain to all four management assertions about account balances: existence, completeness, rights and obligations, and valuation and allocation. The auditor must ensure that they exist and are owned. In addition, the valuation determined by depreciation, amortization, or impairment charges is usually an important issue. Of the four assertions, completeness is probably the least important, but it cannot be ignored.
8.12 Where would an auditor find the proper authorization that indicates it is okay to pay a vendor?
Payment of a vendor is authorized using a voucher package. Once a "three-way" match is performed (matching and reconciling the purchase order, receiving report and vendor invoice) the voucher package is signed off. This sign off is the authorization to pay the vendor.
11.22 What procedures do auditors perform to identify subsequent events?
Procedures performed to identify subsequent events include: · Obtaining an understanding of the procedures performed by management to identify subsequent events. · Inquiring of management and those charged with governance as to the existence of subsequent events (and then corroborate this inquiry through written representations). · Reading minutes of meetings of owners, management, or those charged with governance held after the date of the financial statements. · Reviewing the entity's latest interim financial statements (if applicable).
8.28 How would a policy of mandatory vacations have helped discover the Beta fraud?
If Martha had taken a mandatory vacation, her replacement would probably have questioned the billings from unknown physicians. If the billings stopped, the sharp drop in insurance costs for that period would likely be questioned by Martha's superior and the fraud may be uncovered.
8.8 If an account payable is omitted from the end of the period balance, what are the possible other accounts that may be misstated?
If a credit to accounts payable is omitted, a corresponding debit is also omitted. The debit may include inventory, PPE, prepaid expenses (e.g. prepaid rent), services (e.g. computer repair) and a variety of expenses.
8.6 Why is a service expense a good account for recording a fictitious expense?
If a fictitious expense is included in the records (e.g. an expense to pay a fictitious vendor) there must be a credit to an accounts payable and a debit to a corresponding account. If the debit is for a tangible assets (e.g. inventory, supplies, PPE) someone will want to see the assets or have a record of the receipt of the assets. If the corresponding debit is for a service, no asset exists for inspection and it may be more difficult to verify via documentation. Also, expense accounts get closed at the end of the year. A fraud near the end of the year involving service expenses has a smaller window of discovery.
11.27 What steps should auditors take if, after the audit report release date, they discover that an important audit procedure was omitted?
If an omitted procedure is discovered, the following courses of action would be taken: 1. Verify that (a) the omitted procedure is important in supporting the auditors' opinion and (b) individuals are currently relying on the client's financial statements and reports. 2. If both of the above conditions exist, auditors should perform the omitted procedure or alternative procedures, if practicable. If both do not exist, no further action is necessary. 3. If performing the omitted or alternative procedures allows auditors to support the previously expressed opinion, no further action is necessary. However, if it does not, auditors should formally withdraw the original reports, issue revised reports, and inform persons currently relying on the financial statements.
7.10 Why do you think companies use revenue recognition as a primary means for inflating profits?
Revenue recognition is used as a primary means for inflating profits for several reasons. First, it is not always straightforward when revenues have been earned. Sales can be structured with return provisions or can have other performance provisions attached. Second, the timing of shipments at year-end may be easy to falsify. Third, markets often value companies based on a multiple of its revenue instead of net income.
7.9 What do we mean by revenue recognition? What does GAAP say about proper revenue recognition?
Revenue recognition refers to including revenue in the financial statements. According to GAAP, this is done when revenues are (1) realized or realizable and (2) earned.
11.20 What are some of the benefits of audit documentation review to a public accounting firm?
Some of the benefits of audit documentation review are: · To ensure the audit is conducted in accordance with GAAS. · To provide the firm an opportunity to evaluate the overall quality of the firm's audit practice. · To provide an important component of the training and evaluation of audit staff members. · To allow the firm to adhere to the performance principle, which requires that auditors adequately plan the work and properly supervise any assistants.
11.24 What are subsequently discovered facts?
Subsequently discovered facts are facts that become known to auditors after the date of the auditor's report that, if known by the auditor, could have caused the auditor to revise the auditor's report.
7.1 What is the basic sequence of activities and accounting in a revenue and collection cycle?
The basic sequence of activities and accounting in a revenue and collection cycle is: a. Receiving and processing customer orders. Entering data in an order system and obtaining a credit check. b. Delivering goods and services to customers. Authorizing release from storekeeping to shipping to customer. Entering shipping information in the accounting system. c. Billing customers, producing sales invoices. Accounting for accounts receivable. d. Collecting cash and depositing it in the bank. Accounting for cash receipts. e. Reconciling bank statements.
8.22 What items could indicate a significant risk of fraud in the acquisition and expenditure cycle?
The following are possible red flags indicating a risk of fraud: · Photocopies of invoices in the files. · Vendor's invoices submitted in numerical order. · Vendor's invoice amounts always in round numbers. · Vendor's invoices are consistently slightly lower than the review threshold set by management. · Vendors with only post office box addresses. · Vendors with no listed telephone number. · Matching vendor and employee addresses or telephone numbers. · Multiple vendors at the same address and telephone number. · Vendors not on the approved vendor list. · Knowing the address of the local mail drops (e.g., shipping and packaging stores that accept client mail). These stores could provide a street address for fraudulent companies, adding false legitimacy to their fraudulent invoices.
11.10 Why are written representation and attorney letters obtained near the end of the evidence-gathering process and dated on the date of the auditor's report?
These communications are obtained near the end of fieldwork and dated on or near the date of the auditor's report to ensure that the most current information has been considered and evaluated by auditors. (Written representations must be dated on the date of the auditor's report).
7.20 Which audit procedures are usually the most useful for auditing the existence assertion?
These procedures are usually the most useful for auditing the existence assertion: Confirmation. Letters of confirmation asking for a report of the balances owed to the company can be sent to customers. Verbal Inquiry. Inquiries to management usually do not provide very convincing evidence about existence and ownership. However, inquiries about the company's agreements to pledge or sell with recourse accounts receivable in connection with financings should always be made. Examination of Documents (vouching). Evidence of existence can be obtained by examining shipping documents. Examination of loan documents may yield evidence of the need to disclose receivables pledged as loan collateral. Scanning. Assets are supposed to have debit balances. A computer can be used to scan large files of accounts receivable, inventory, and fixed assets for uncharacteristic credit balances. The names of debtors can be scanned for officers, directors, and related parties, amounts for which need to be reported separately or disclosed in the financial statements. Analytical Procedures. Comparisons of asset and revenue balances with recent history might help detect overstatements. Relationships such as receivables turnover, gross margin ratio, and sales/asset ratios can be compared to historical data and industry statistics for evidence of overall reasonableness. Account interrelationships also can be used in analytical review. For example, sales returns and allowances and sales commissions generally vary directly with dollar sales volume, bad debt expense usually varies directly with credit sales volume, and freight expense varies with the physical sales volume. Accounts receivable write‑offs should be compared with earlier estimates of doubtful accounts.
7.26 What procedures should be performed to determine the adequacy of the allowance for doubtful accounts?
To determine the adequacy of the allowance for doubtful accounts, the auditor reviews subsequent cash receipts from the customer, discusses unpaid accounts with the credit manager, and examines the credit files. These should contain the customer's financial statements, credit reports, and correspondence between the client and the customer. Based on this evidence, the auditor estimates the likely amount of nonpayment for the customer, which is included in the estimate of the allowance for doubtful accounts. In addition, an allowance should be estimated for all other customers, perhaps as a percentage of the current accounts and a higher percentage of past due accounts. The auditor compares his or her estimate to the balance in the allowance account and proposes an adjusting entry for the difference.
8.3 Why is a "blind" purchase order used as a receiving report document?
A "blind" purchase order is a purchase order that does not display the quantity ordered. It is given to the receiving department so personnel there will know what has been ordered, but they will have to do an independent count. If a blind purchase order is not used, receiving personnel may not count the goods received and just record the amount indicated on the purchase order.
11.29 What is management letter? Are management letters required by generally accepted auditing standards?
A management letter contains a summary of recommendations to allow the client to improve the effectiveness and efficiency of its operations. They are not required by generally accepted auditing standards.
7.22 Distinguish between positive and negative confirmations. Under what conditions would you expect each type of confirmation to be appropriate?
A positive confirmation is a request for a response from an independent party whom the auditor has reason to expect is able to reply. A negative confirmation is a request for a response from the independent party only if the information is disputed. Negative confirmations should be sent only if the recipient can be expected to detect an error and reply accordingly. They are normally used for accounts with small balances when control risk is low.
8.2 How can purchasing managers use their position to defraud the company? What can be done to prevent it?
A purchasing manager can direct purchases toward vendors who provide the manager kickbacks or other inducements. This can be prevented by notifying suppliers that the company will not permit payment of kickbacks to its employees. The company can also rotate purchasing managers to different vendors. Finally, significant purchases should be reviewed and approved by a higher level manager.
11.21 What is a subsequent event?
A subsequent event is an event occurring between the date of the financial statements and the date of the auditor's report.
7.19 Why is it important to emphasize the existence assertion when auditing accounts receivable?
Accounts receivable is often the debit entry when Sales Revenue is recognized - particularly if the sale is being recognized fraudulently. In these cases, cash would not be received, so the fictitious balance would end up in accounts receivable. As a result, auditors are concerned about the validity or existence of accounts receivable. Note that auditors are also concerned about the valuation assertion for accounts receivable - just because someone owes a company money does not mean they will pay that amount.
11.16 What is an uncorrected misstatement? What is the auditors' responsibility for communicating misstatements detected during the audit?
An uncorrected misstatement is a misstatement that the auditor has identified and accumulated during the audit that has not been corrected (or adjusted) by the client. Auditors are required to communicate all uncorrected misstatements detected during the audit to individuals charged with governance (such as the client's audit committee), regardless of the materiality of these misstatements to the client's financial statements. Often, management decides not to make all of the proposed corrections because of materiality or cost-benefit considerations.
11.7 What is the typical content of attorney letters?
Attorney letters ordinarily contain the following information: · A list of pending or threatened litigation, claims, or assessments. · A description of each item, including the nature of the case and management responses or intended responses to the case. · An evaluation of the likelihood of an unfavorable outcome. · An estimate of the range of potential loss.
11.12 What responsibility do auditors have for evaluating a client's ability to continue as a going concern?
Auditors are required to consider whether any evidence that comes to their attention during the audit examination provides substantial doubt about the client's ability to continue as a going concern for a period not to exceed one year beyond the date of the financial statements being audited.
11.5 What are auditors' responsibilities with respect to accounting estimates made by management?
Auditors are responsible for evaluating management's process for developing estimates as well as the overall reasonableness of management's estimates.
7.4 What system-generated reports might auditors examine to find evidence of unrecorded sales? Of inadequate credit checks? Of incorrect product unit prices?
Auditors could examine these files for evidence of: · Unrecorded sales — pending order master file, · Inadequate credit checks — credit data/check files · Incorrect product unit prices — price list master file
7.31 In the case of Bill Often, Bill Early, what information might have been obtained from inquiries? From tests of controls? From observations? From confirmations?
Auditors might have obtained the following information: Inquiries: Personnel admitting the practices of backdating shipping documents in a "bill-and-hold" tactic or personnel describing the 60‑day wait for a special journal entry to record customer discounts taken. Tests of Controls: The sample of customer payment cash receipts would have shown no discount calculations and authorizations, leading to inquiries about the manner and timing of recording the discounts. Observation: When observing the physical inventory‑taking, special notice should be taken of any goods on the premises but excluded from the inventory. These are often signs of sales recorded too early. Confirmations of Accounts Receivable: Customers who had not yet been given credit for their discounts can be expected to take exception to a balance that is too high.
7.24 What special care should be taken with regard to examining the sources (e.g., emailed copy) of accounts receivable confirmation responses?
Auditors need to take special care in examining sources of accounts receivable confirmation responses. Auditors need to control the confirmations, including the addresses to which they are sent. History is full of cases in which confirmations were mailed to company accomplices who had provided false responses. The auditors should carefully consider features of the reply such as postmarks, FAX, and email responses, letterhead, electronic mail, telephone number, or other characteristics that may give clues to indicate false responses. Auditors should follow up electronic and telephone responses to determine their origin (for example, returning the telephone call to a known number, looking up telephone numbers to determine addresses, or using a crisscross directory to determine the location of a respondent).
11.28 Identify information that auditors are required to communicate to individuals charged with governance of the client.
Auditors should communicate the following information to individuals charged with governance: · Auditors' responsibility under generally accepted auditing standards. · An overview of the planned scope and timing of the audit. · Auditors' judgment about the quality of the client's accounting policies, accounting estimates, and financial statement disclosures. · Any significant difficulties encountered during the audit. · Any uncorrected misstatements, other than those auditors believe to be trivial. · Any disagreements with management. · Material, corrected misstatements that were brought to the attention of management. · Representations requested from the client's management. · Any management consultations with other auditors. · Any significant issues arising from the audit that were discussed with management. · Other findings or issues that are significant and relevant to those charged with governance.
7.14 What effect do entity-level controls have on the control risk assessments of an auditor?
Entity level controls provide an additional level of assurance for the auditor related to control risk. For example, if the client has a strong audit committee, this provides additional assurance that appropriate oversight is being conducted internally. Control risk assessment should always be conducted in a top-down approach, with entity level controls considered initially.
11.13 What factors may indicate that substantial doubt exists about the client's ability to continue as a going concern?
Factors that may indicate that substantial doubt exists about the client's ability to continue as a going concern include: · Negative trends, such as recurring operating losses, working capital deficiencies, and negative cash flow from operations. · Signals of financial difficulties, such as default on loans, denial of trade credit from suppliers, restructuring of debts, or arrearages in dividends. · Internal matters such as work stoppages or substantial dependence on the success of a particular project or activity. · External matters, such as legal proceedings; loss of a key franchise, license, or patent; or loss of a major customer or supplier.
8.17 In substantive procedures, why is the emphasis on the completeness assertion for liabilities instead of on the existence assertion as in the audit of assets?
Financial statement users are most troubled by overstated assets and understated liabilities. Therefore, they need to audit more for the existence of assets and the completeness of liabilities.
11.14 What actions should auditors take if evidence suggests that substantial doubt exists about the client's ability to continue as a going concern?
If evidence suggests that substantial doubt exists about the client's ability to continue as a going concern, auditors should obtain information about management's plans to mitigate the effect of these factors and assess the likelihood that these plans can be effectively implemented. If after evaluating this evidence, auditors believe that substantial doubt continues to exist about the client's ability to continue as a going concern, auditors should ensure that appropriate disclosures are provided in the financial statements and issue an unmodified opinion with a separate section in the report with the heading Substantial Doubt About the Entity's Ability to Continue as a Going Concern. On the other hand, if auditors conclude that the risk of going-concern uncertainties is low, no disclosures or report modifications are necessary.
11.11 How should auditors respond if the client refuses to furnish written representations?
If the client refuses to furnish written representations, auditors may either qualify or disclaim an opinion as with other scope limitations. However, because of the importance of this communication, auditors should be very skeptical if the client refuses to furnish written representations.
7.13 The primary control procedure to ensure the occurrence of revenues requires which three documents to be matched prior to recording sales revenue?
In a standard revenue cycle, a three-way match of a customer purchase order, evidence of shipment (perhaps a bill of lading), and a customer invoice provides the best evidence of a completed sale. A company should generally not recognize revenue until all three documents are present. This control will provide assurance about the occurrence of revenues and the existence of accounts receivable.
11.8 In addition to obtaining responses to attorney letters, what other procedures can be used to gather audit evidence regarding litigation, claims, and assessments?
In addition to attorney letters, auditors would ordinarily perform the following with respect to litigation, claims, and assessments: · Obtain from management a description of litigation, claims, and assessments. · Examine documents in the client's possession regarding litigation, claims, and assessments, including correspondence and invoices from attorneys. · Obtain assurance from management that it has disclosed all material unasserted claims of probable litigation about which the attorney has advised them. · Read minutes of meetings of stockholders, directors, and appropriate committees. · Read contracts, loan agreements, leases, and correspondence from taxing or other governmental agencies. · Obtain information concerning guarantees from bank confirmations. · Review the legal expense account and cash disbursements records and invoices related to legal services.
7.28 In the case of The Canny Cashier, name one control that could have revealed signs of the embezzlement.
In the Canny Cashier case, if someone other than the assistant controller had reconciled the bank statement and compared the details of bank deposit slips to cash remittance reports, the discrepancies could have been noted and followed up. The discrepancies were that customers and amounts on the bank deposit slips to cash remittance reports did not match.
8.10 What feature of the acquisition and expenditure control would be expected to prevent an employee's embezzling cash through creation of fictitious vouchers?
In the acquisition and expenditure cycle those individuals authorizing procurement of goods and services (i.e. purchasing) should be separate from record keeping (i.e. accounts payable) and from the various departments that receive, store, and use the material received (e.g. inventory, production, warehousing, engineering, receiving).
8.7 What are the short-term and the long-term effects of improperly capitalizing expenditures on the financial statements?
In the short term, capitalizing ordinary expenditures increases assets and decreases expenditures. Therefore, this type of manipulation makes the balance sheet and income statements appear better. However, capitalized expenses need to be amortized in future periods, so these improperly capitalized expenditures show up in future periods as additional expenses and reduced assets.
11.1 Identify four primary periods in an audit examination and the tasks and activities that occur in each.
The four primary periods in an audit examination and the tasks and activities that fall within each time period are: 1. Between the beginning of the year and date of the financial statements: interim tests of controls and substantive procedures. 2. Between the date of the financial statements and the date of the auditor's report: (1) completing substantive procedures, (2) obtaining attorneys' letters, (3) obtaining written representations, (4) making going-concern assessment, (5) evaluating the need for adjusting journal entries, (6) reviewing audit documentation, (7) identifying and evaluating subsequent events. 3. Between the date of the auditor's report and audit report release date: subsequently discovered facts. 4. Following the audit report release date: (1) subsequently discovered facts, (2) omitted audit procedures, (3) management letters, (4) communications with those charged with governance.
11.9 What are the major categories of information contained in written representations?
The major categories of information contained in written representations are: 1. The entity's financial statements, including: · Management's responsibilities for the financial statements and internal control over financial reporting. · The appropriate disclosure, presentation, and reasonableness of certain items (accounting estimates, related parties, subsequent events, and litigation and claims). · A statement that uncorrected misstatements are immaterial to the financial statements taken as a whole. 2. Information provided to the auditors, both in general and related to sensitive areas (fraud, noncompliance with laws and regulations, litigation, and related-party transactions). 3. Internal control over financial reporting (for audits of public entities).
8.16 Describe the purpose and give examples of audit procedures in the search for unrecorded liabilities.
The purpose of the auditor's search for unrecorded liabilities is to gather evidence as to whether the completeness assertion is true. From an evidence-gathering perspective, it is much more difficult to gather evidence on unrecorded transactions than to gather evidence that recorded account balances exist. · Inquire of client personnel about their procedures for ensuring that all liabilities are recorded. · Scan the open purchase order file at year-end for indications of material purchase commitments at fixed prices. Obtain current prices and determine whether any adjustments for loss and liability for purchase commitments are needed. · Examine the unmatched vendor invoices listing and determine when the goods were received, looking to the unmatched receiving report file and receiving reports prepared after the year-end. Determine which invoices, if any, should be recorded. · Trace the unmatched receiving reports to accounts payable entries, and determine whether entries recorded in the next accounting period need to be adjusted to report them in the current accounting period under audit. · Select a sample of cash disbursements from the accounting period following the balance sheet date. Vouch them to supporting documents (invoice, receiving report) to determine whether the related liabilities were recorded in the proper accounting period. · Confirm accounts payable with vendors (especially regular suppliers showing small or zero balances in the year-end accounts payable.
7.16 What is a walkthrough of a sales transaction? How can the walkthrough work complement the use of an internal control questionnaire?
The purpose of the walkthrough is to obtain an understanding of the transaction flow, the control procedures, and the populations of documents that may be utilized in tests of controls. In a walkthrough of a sales transaction, auditors take a small sample (usually 1-3 items) of a sales transaction and trace it from the initial customer order through credit approval, billing, and delivery of goods to the entry in the sales journal and subsidiary accounts receivable records, and then its subsequent collection and cash deposit. Sample documents are collected, and employees in each department are questioned about their specific duties. The information gained from documents and employees can be compared to answers obtained on an internal control questionnaire to ensure proper procedures are taking place.
11.17 Identify the two methods of evaluating the performance materiality of uncorrected misstatements. What are the requirements of Staff Accounting Bulletin No. 108 for evaluating the performance materiality of these misstatements?
The rollover method considers only the current-period income effect(s) of any misstatements. In contrast, the iron curtain method considers the aggregate effect of the misstatements on the entity's balance sheet. Staff Accounting Bulletin No. 108 requires auditors to evaluate misstatements using both methods and propose an adjustment if either method indicates that the misstatement exceeds the level of performance materiality.
7.29 What feature(s) could SEI have installed in its cash receipts internal controls that would have been expected to prevent the cash receipts journal and recorded cash sales from reflecting more than the amount shown on the daily deposit slips?
To prevent the cash receipts journal and recorded cash sales from reflecting more than the amount shown on the daily deposit slip, internal controls should ensure that receipts are recorded daily and are complete. A careful bank reconciliation by an independent person may detect such errors.
8.18 How do audit procedures for prepaid expenses and accrued liabilities also provide audit evidence about related expense accounts?
Typically, when auditing prepaids and accruals, the auditor uses audit documentation that shows beginning balances, payments, expense, and ending balance. By agreeing beginning balance to prior-years audit documentation, vouching payments, and calculating the accuracy of the ending balance, the auditor knows that the amount charged to expense will be correct.
7.25 What alternative procedures should be applied to accounts that do not return confirmations?
When positive confirmations are not returned, the auditor should perform the following procedures: a. Send second and even third requests. b. Examine subsequent cash receipts. c. Examine sales orders, invoices, and shipping documents. d. Examine correspondence files for past due accounts.
11.6 What are the responsibilities of (a) client management, (b) auditors, and (c) the client's attorneys with respect to obtaining evidence regarding litigation, claims, and assessments?
a. The responsibilities of client management are to (1) respond to auditors' inquiries regarding litigation, claims, and assessments, (2) provide auditors with a listing, description, and evaluation of litigation, claims, and assessments, and, (3) prepare letter to attorney (attorney letter) that includes information related to litigation, claims, and assessments. b. The responsibilities of auditors are to (1) inquire of client regarding the existence of litigation, claims, and assessments, (2) perform various audit procedures regarding litigation, claims, and assessments, (3) initiate the request to the client for the attorney letter, and (4) mail attorney letter prepared by client. c. The responsibility of the client's attorneys is to respond to auditors regarding the client's description of litigation, claims, and assessments.
