Ch 16 - Audit Operations and Completion
Substantive Tests for SG&A* Expenses - OBTAIN / PREP ANALYSIS OF SELECTED ACCOUNT
Examine accounts based on results of analytical procedures FOR EXAMPLE: Advertising Research and development Legal expenses and other professional fees Maintenance and repairs Rents and royalties
Payroll fraud had been common and often substantial but now fraud difficult to conceal (according to text authors) because of:
Extensive segregation of duties relating to payroll Use of computers with proper controls for preparation of payrolls Filing of frequent payroll reports to the government
A possible loss, stemming from past events that will be resolved as to existence and amount by some future event, is referred to as a(n): Analytical process. Loss contingency. Probable loss. Unasserted claim.
Loss contingency. A loss contingency is a possible loss stemming from past events that will be resolved in the future.
Which of the following procedures is most likely to be included in the final review stage of an audit? Obtain an understanding of internal control. Confirmation of receivables. Observation of inventory. Perform analytical procedures.
Perform analytical procedures. The performance of analytical procedures is a required part of the final review stage of an audit and is therefore most likely to be included in that stage of the audit.
A client's previous two years of financial statements understated estimated warranty payable by $15,000 and $25,000 respectively, immaterial amounts. This year the auditors estimate that the accrual is understated by an additional $30,000. In this year's audit $50,000 represents a material amount. Assuming that the entire understatement is to be recorded, following SEC SAB 108 the decrease in this year's income due to these understatements is: A) $0. B) $30,000. C) $55,000. D) $70,000.
$70,000.
Management estimates the company's allowance for doubtful accounts as $100,000, and the auditors develop an estimate that suggests that the amount should be between $115,000 and $125,000. The likely misstatement in this situation is: A) $0. B) $15,000. C) $20,000. D) $25,000.
$15,000.
loss contingencies are reflected in the financial statement amounts when two conditions are met
1. it is probable that the loss has been sustained before the BS date 2. the amount of the loss can be reasonably estimated
Likely misstatements
Due to extrapolation from audit evidence or differences in accounting estimates
The aggregated misstatement in the financial statements is made up of: Known Misstatements Projected Misstatements Other Misstatements Yes Yes Yes Yes Yes No No Yes No No Yes Yes
Yes Yes Yes The total aggregate misstatements composed of: (a) known misstatements, (b) projected misstatements and (c) other misstatements.
Review of work of audit staff accomplished through review of
audit working papers
Required Communication with Those Charged with Governance**
**typically the audit committee Auditor responsibility under GAAS (e.g. to form and express an opinion) & management's responsibilities An overview of the planned scope & timing of audit Significant findings from the audit
letter of inquiry to clients legal counsel
-evidence of pending and threatened litigation -unasserted claims need to be disclosed if probable and reasonably possible
Which of the following is not correct concerning a type I and a type II subsequent event? A) A type I may require adjustment to financial statements while a type II will not. B) Both a type I and a type II subsequent event may require note disclosure. C) A type I is an event that occurred prior to year end, but was discovered after, while a type II is one that arose subsequent to year end. D) A type II event may require adjustment to the financial statements and a type I may require note disclosure.
A type II event may require adjustment to the financial statements and a type I may require note disclosure.
Post-Audit Responsibilities
Advise client to make appropriate disclosure of the facts to anyone actually or likely to be relying upon the audit report and financial statements If client refuses to make disclosure, CPA should inform each member of board and notify regulatory agencies
Conservatism in the Measurement of Income
Assets - accountants choose lower of two or more reasonable alternative values Liabilities - higher amount is chosen Results in income statement with a low or conservative income figure
SAS 12
Auditors should obtain from management a list describing and evaluating threatened or pending litigation
When auditing the statement of cash flows, which of the following would an auditor not expect to be a source of receipts and payments? Capitalization. Financing. Investing. Operations.
Capitalization. The three sections of a statement of cash flows relate to operating, financing, and investing . Capitalization is not one of the sections.
What audit procedure is not ordinarily used to examine selling, general and administrative expenses? A) Analytical procedures B) Use of budgets to identify unexpected differences C) Confirmations to advertising agencies confirming payments D) Detailed tests of balances
Confirmations to advertising agencies confirming payments
The search for unrecorded liabilities for a public company includes procedures usually performed through the: Day the audit report is issued. End of the client's year. Date of the auditors' report. Date the report is filed with the SEC.
Date of the auditors' report. The search for unrecorded liabilities should be completed as of the last day possible—ordinarily near the date of the audit report.
Subsequent to the issuance of the auditor's report, the auditor became aware of facts existing at the report date that would have affected the report had the auditor then been aware of such facts. After determining that the information is reliable, the auditor should next: Notify the board of directors that the auditor's report must no longer be associated with the financial statements. Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. Request that management disclose the effects of the newly discovered information by adding a footnote to subsequently issued financial statements. Issue revised pro forma financial statements taking into consideration the newly discovered information.
Determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. When the auditor becomes aware of facts existing at the report date that would have affected the report, s/he should next determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information. If such persons are believed to exist, the next step is to determine the best manner in which to disclose the information.
Substantive Tests for SG&A* Expenses - ANALYTICAL
Develop an expectation of the account balance Determine the amount of difference from the expectation that can be accepted without investigation Compare the company's account balance with the expected account balance Investigate significant deviations from the expected account balance
Subsequent Discovery of Omitted Audit Procedures
Discovered during peer review or other subsequent review of working papers Assess importance of omitted procedures to their previously issued opinion
A common audit procedure in the audit of payroll transactions involves vouching selected items from the payroll journal to employee time cards that have been approved by supervisory personnel. This procedure is designed to provide evidence in support of the audit objective of determining that: A) Only bona fide employees worked and their pay was properly computed. B) Jobs on which employees worked were charged with the appropriate labor cost. C) Controls relating to disbursements are operating properly. D) Employees worked the number of hours for which their pay was computed.
Employees worked the number of hours for which their pay was computed.
An auditor accepted an engagement to audit the 20X8 financial statements of EFG Corporation and began the fieldwork on September 30, 20X8. EFG gave the auditor the 20X8 financial statements on January 17, 20X9. The auditor completed the audit on February 10, 20X9, and delivered the report on February 16, 20X9. The client's representation letter normally would be dated: December 31, 20X8. January 17, 20X9. February 10, 20X9. February 16, 20X9.
February 10, 20X9. The representation letter should be dated as of the date the audit was completed.
Separate departments should handle: Employment (personnel) Timekeeping Payroll preparation and record keeping Distribution of pay to employees
HR OPS ACCTING DM
Other Contingencies
Income tax disputes Accommodation endorsements and other guarantees of indebtedness Accounts receivable sold or assigned with recourse Environmental issues Commitments General risk contingencies
Loss contingencies should be reflected in the financial statement amounts when two conditions are met
It is probable that a loss had been sustained before the balance sheet date The amount of the loss can be reasonably estimated
In evaluating whether there is a sufficiently low probability of material misstatement in the financial statements, the auditors accumulate: A) Likely misstatements in the financial statements. B) Known misstatements in the financial statements. C) Known, projected and other estimated misstatements in the financial statements. D) Known, projected and potential misstatements in the financial statements.
Known, projected and other estimated misstatements in the financial statements.
Likely Qualitative Materiality Factors
Mask a change in earnings or other trends. Hide a failure to meet analysts' consensus expectations for the company. Change a loss into income, or vice versa. Affect compliance with regulatory requirements, loan covenants, or other contractual requirements. Increase management's compensation
Evaluation
Material misstatements must be corrected Quantitative and qualitative factors
What is ordinarily the primary concern when auditing the income statement? A) Overstatement of Revenues, Expenses and Net Income B) Overstatement of Revenues and Expenses, and understatement of Net Income C) Overstatement of Net Income and understatement of Revenues and Expenses D) Overstatement of Revenues and Net Income, and understatement of Expenses
Overstatement of Revenues and Net Income, and understatement of Expenses
typically largest operating cost
PAYROLL
To have strong internal control over payroll, which of the following functions does not need to be separated from the others? A) Personnel B) Timekeeping C) Payroll preparation D) Personnel verification
Personnel verification
Miscellaneous Revenue Auditor should
Propose adjusting journal entry to classify items correctly Perform analytical procedures and investigate unusual fluctuations (i.e. "flux" analysis)
The auditors' best course of action with respect to "other financial information" included in a client prepared annual report containing the auditors' report is to: A) Indicate in the auditors' report that the "other financial information" is unaudited. B) Consider whether the "other financial information" is accurate by performing a review. C) Obtain written representations from management as to the material accuracy of the "other financial information." D) Read and consider the manner of presentation of the "other financial information."
Read and consider the manner of presentation of the "other financial information."
In auditing the balance sheet, most revenue and expense accounts are also audited. Which accounts are most likely to be audited when auditing Accounts Receivable? A) Sales and Cost of Goods Sold B) Interest and Bad Debt Expense C) Sales and Bad Debt Expense D) Interest and Cost of Goods Sold
Sales and Bad Debt Expense
Audit Procedures Completed Near the End of Field Work
Search for unrecorded liabilities Review the minutes of meetings Perform final analytical procedures Perform procedures to identify loss contingencies Perform the review for subsequent events Obtain the representation letter
Which of the following events occurring on January 5, 20X2, is most likely to result in an adjusting entry to the 20X1 financial statements? A business combination. Early retirement of bonds payable. Settlement of litigation. Plant closure due to a strike.
Settlement of litigation. The settlement of litigation is most likely to result in an adjusting entry (i.e., be a "Type 1 subsequent event) because the cause of the litigation most likely occurred before 20X2.
Known misstatements
Specific misstatements identified during the course of the audit
Which of the following is not a procedure to discover unasserted claims or contingent liabilities? A) Review of Board of Director minutes B) Sending a letter of inquiry to a client's attorney C) Substantive testing of company prepaid assets D) Searching newspapers and other periodicals for stories on the client and its indust
Substantive testing of company prepaid assets
Which of the following is least likely to be considered a substantive procedure relating to payroll? Investigate fluctuations in salaries, wages, and commissions. Test computations of compensation under profit sharing for bonus plans. Test commission earnings. Test whether employee time reports are approved by supervisors.
Test whether employee time reports are approved by supervisors. Testing whether employee time reports are approved by supervisors is an example of a test of a control, not a substantive procedure.
Auditors should perform audit procedures relating to subsequent events: A) Through year end. B) Through issuance of the audit report. C) Through the date of the audit report. D) For a reasonable period after year end.
Through the date of the audit report.
A company oil tanker recently spilled a large amount of oil in a pristine fishing area. No lawsuits have yet been filed. What is the audit issue? A) Account payable B) Unasserted claim C) Valuation of oil & gas holdings D) General risk contingency
Unasserted claim
SAS 12
auditors should obtain from management a list describing and evaluating threatened or pending litigation
SOD for payroll
employment (HR) Timekeeping (ops) payroll prep and record keeping (accting) distribution of pay to employees (DM)
Substantive Tests for SG&A* Expenses - ALSO OBTAIN / PREP ANALYSIS OF CRITICAL
expenses in the income tax return
Partner and manager devote attention to accounts with
higher risk of material misstatement
Second partner review prior to
issuance of audit report
Loss contingencies should be disclosed in the notes to the financial statements when
it is at least reasonably possible that a loss has been sustained
Review of working papers not completed until
near (of after) completion of fieldwork
Unasserted claims
need to be disclosed if probable and reasonably possible
Most common loss contingency -
pending or threatened litigation
most common loss contingency
pending or threatened litigation
Typically performed by
seniors then managers
Measurement of income is generally regarded as the
single most important function of accounting
Loss contingencies need not be disclosed when
the possibility of loss is remote
As a result of analytical procedures, the independent auditors determine that the gross profit percentage has declined from 30 percent in the preceding year to 20 percent in the current year. The auditors should: Express an opinion that is qualified due to the inability of the client company to continue as a going concern. Evaluate management's performance in causing this decline. Require note disclosure. Consider the possibility of a misstatement in the financial statements.
Consider the possibility of a misstatement in the financial statements. The purpose of analytical procedures is to locate potential misstatements in the financial statements. The auditors should investigate this significant fluctuation to determine whether it results from a financial statement misstatement.
