CPA Aud- Module 8

The relevant AICPA guidance is provided by AU 450, Evaluation of Misstatements Identified During the Audit. This pronouncement states that the auditor's objectives are to evaluate the effect of

(1) identified misstatements on the audit; and (2) uncorrected misstatements, if any, on the financial statements.

The reliability of the expectation increases when the data used is

(1) obtained from independent outside sources; (2) when it is subject to audit testing (either currently or in the past); or (3) is developed under conditions of effective internal control.

Basis for Risk Assessment—The auditor should obtain an understanding of the following:

The requirements of the applicable financial reporting framework How management makes the accounting estimates and the data used, including how management has assessed the effect of estimation uncertainty

—Substantive analytical procedures may be particularly effective in testing for omissions of transactions that would be hard to detect with procedures that focus on _____

recorded amounts.

Inventory turnover

COGS/Average Inventory

After the documentation completion date—No documentation can be deleted, but documentation ______ (must indicate the date the information was added, the name of the person preparing the additional documentation, and the reason for adding it).

Can be added

Further Substantive Procedures to Respond to Significant Risks—The auditor should evaluate the following:

How management addressed estimation uncertainty in making the accounting estimate; Whether management's significant assumptions are reasonable; and When relevant, whether management has the intent and ability to carry out specific actions.

Additional Specific Considerations under PCAOB Auditing Standards To test accounting estimates—Should perform one or more of the following:

Test the company's process for developing the accounting estimate. Develop an independent expectation for comparison. Evaluate evidence from events occurring after the measurement date.

The AICPA states that the effectiveness and efficiency of substantive analytical procedures depends on the following four factors or considerations:

Nature of the assertion Plausibility and predicability of the relationship Availability and reliability of date used Precision of the expectation

_____ Facts that become known to the auditor after the date of the auditor's report that, had they been known to the auditor at that date, may have caused the auditor to revise the auditor's report.

Subsequently Discovered Facts:

_____An audit procedure designed to evaluate the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the assertion level. (Note that the auditor must perform tests of controls when the risk assessment includes an expectation of the operating effectiveness of controls or when the substantive procedures alone do not provide sufficient appropriate audit evidence.)

Test of controls

_____- Verifying the client's recorded amounts by testing those relative few debits and credits (the transactions) that caused the account balance to change from last year's audited balance to this year's recorded balance.

Test of transactions

AU _____ also states, "If the auditor has determined that an assessed risk of material misstatement at the relevant assertion level is a significant risk, the auditor should perform substantive procedures that are specifically responsive to that risk.

330

Number of days sales in inventory=

365 days/Inventory turnover

Number of days sales in receivables=

365days/ receivables turnover

Definition of substantive procedures

An audit procedure designed to detect material misstatements at the assertion level. Substantive procedures comprise (a) tests of details (classes of transactions, account balances, and disclosures) and (b) substantive analytical procedures.

The auditor should obtain sufficient appropriate audit evidence as to whether the disclosures meet the requirements of the applicable____. For accounting estimates resulting in significant risks, the auditor should evaluate the adequacy of the disclosure of estimation uncertainty.

Applicable financial framework

Nature of Substantive Procedures—These should be responsive to the planned level of detection risk; they consist of:

Tests of details Substantive analytical procedures (should consider testing the controls over the preparation of information used in connection with analytical

Using Pricing Information from a Broker or DealerThe relevance and reliability of the evidence provided depends on whether

The broker or dealer has a relationship with the company. The broker or dealer is a "market maker" that deals in the same type of financial instrument. The quote reflects market conditions as of the financial statement date. The quote is binding on the broker or dealer. There are any restrictions, limitations, or disclaimers in the quote.

PCAOB on "Evaluating Audit Results" The auditor must reach a conclusion as to whether sufficient appropriate _ has been obtained to support the opinion.

audit evidence

If Management Revises the Financial Statements—The auditor should perform appropriate ______ If Management Does Not Revise the Financial Statements—If the auditor believes that revision is necessary, the auditor should appropriately ______

audit procedures on the revision. modify the opinion.

PCAOB ON AUDIT PLANNING"Overall strategy —Involves rather high-level _______issues involving the scope, timing, and direction of the audit (guides the development of the more specific audit plan).

audit resource allocation

The representations letter should cover all periods encompassed by the ___. If current management was not present for all periods covered, tailor the representations to the circumstances.

auditor's report.

Documentation—The auditor should document the following:

The basis for the auditor's conclusions about the reasonableness of fair value accounting estimates resulting in significant risks and their disclosure, andAny indications of possible management bias

The auditor should draft a letter of inquiry for management to send to those lawyers who have rendered litigation-related services to the entity. The lawyer's response to the letter of inquiry is simply called the lawyer's letter (or attorney's letter ). The primary purpose of the lawyer's letter is to

corroborate management's responses to the auditor's inquiries about legal-related contingencies.

Consider all relevant audit evidence—The auditor should consider whether the audit evidence appears to _____the relevant assertions in the financial statements.

corroborate or to contradict

PCAOB on "Audit Evidence" Sufficiency relates to the quantity of evidence required—the amount of evidence needed increases as the risk of material misstatement increases; The amount of evidence needed ____ as the quality of the underlying evidence ______. Appropriateness relates to the quality of evidence, which involves ____ & ____

decreases; increases relevance and reliability

Performing substantive procedures at an interim date increases _____risk. The auditor should perform additional substantive procedures (or substantive procedures combined with tests of control) to mitigate the increased risk and provide a reasonable basis for extending the audit conclusions from the interim date to year-end.

detection

Tests of Ending Balances: Verifying the client's recorded amounts by ________

directly testing the composition making up the ending account balance.

The Auditor's Responsibilities Under the SAS Relevant information about the related parties should be shared with the members of the

engagement team.

If any such representations are contradicted by other evidence—the auditor should investigate the circumstances and evaluate the implications to reliance on other

management representations.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis Period beyond management's evaluation—Should inquire of management about any conditions or events after the __________- that may be relevant to the entity's ability to continue as a going concern.

period of management's evaluation

When planning to perform substantive analytical procedures for the period following the interim date, the auditor should consider whether the period-end balances are_____ as to amount, relative significance, and composition.

reasonably predictable

Other (undetected) misstatements may exist when a misstatement results from a break down in internal control, or when inappropriate assumptions or valuation methods have been widely used. The auditor should consider

whether the detected and undetected misstatements might exceed materiality.

AICPA's definition n of arm's-length transaction:

"A transaction conducted on such terms and conditions between a willing buyer and a willing seller who are unrelated and are acting independently of each other and pursuing their own best interests. "

The auditor's basis for conclusion is comprised of three categories of procedures:

Risk assessment procedures Tests of controls Substantive procedures

The PCAOB risk assessment standards apply to integrated audits of issuers (encompassing both the company's financial statements and internal control over financial reporting), whereas the AICPA risk

assessment standard apply solely to audits of non-issuers' financial statements.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis identify the conditions or events that would raise substantial doubt. When conditions or events raise substantial doubt—There may be a need for additional procedures).

audit

Definition Negative Confirmation Request: A request that the confirming party respond directly to the

auditor only if the confirming party disagrees with the information provided in the request.

Date of the management representations letter—the representations letter should be dated the same as the date of the

auditor's report.

Reporting—When there is significant uncertainty, the auditor may add an emphasis-of-matter paragraph to the

auditor's report.

This letter from management is addressed directly to the

auditors.

These PCAOB Auditing Standards are applicable to integrated audits of an issuer's financial statements and the internal controls over financial reporting. In contrast, the AICPA's Statements on Auditing Standards focus solely on ______

audits of nonissuers' financial statements.

The auditor should consider whether the accounting estimates might indicate possible management bias. Documentation—The auditor should include documentation regarding

(1) the basis for the auditor's conclusions about the reasonableness of accounting estimates resulting in significant risks and their disclosure; and (2) any indications of possible management bias. The auditor usually obtains written representations as to whether management believes assumptions used in making accounting estimates are reasonable.

Quick Ratio (acid test ratio)

(Cash + Marketable securities + A/R) Current Liabilities

The reliability of pricing information provided is affected by

(a) the pricing service's experience and expertise and (b) whether the pricing service has a relationship with the company

The relevant AICPA guidance is provided by AU ____, Audit Evidence. This pronouncement states that the auditor's objective is to "obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base the auditor's opinion."

500

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU ____, Audit Evidence—Specific Considerations for Selected Items. This pronouncement states that the auditor's objective is "to obtain sufficient appropriate audit evidence regarding the completeness of litigation, claims, and assessments involving the entity" (among other matters specifically addressed by the SAS).

501

Negative Confirmation Request—Where a response is only requested in the event of disagreement. A nonresponse is viewed as evidence of agreement by the recipient:

Could easily misinterpret a nonresponse as suggesting agreement when, instead, the other party did not even open the envelope! Therefore, negative confirmations usually require a larger sample size than would positive confirmations.

Working Capital -

Currect assets- Current liabilities

Current ratio=

Current assets/current liabilities

PCAOB on "Audit Evidence" Financial statement assertions are factual representations that are implicitly or explicitly made by management—The PCAOB identified the five traditional financial statement assertions previously presented in a now-superseded Statement on Auditing Standards:

Existence Completeness Rights and obligations valuation or allocation presentation and disclosure

________A request that the confirming party respond directly to the auditor by providing the requested information or indicating whether the confirming party agrees or disagrees with the information in the request.

Positive confirmation request

Analytical Procedures—The auditor must document:

The expectation and factors (sources) considered in developing it, when not otherwise apparent The results of the comparison of that expectation to the recorded amounts (or to ratios based on recorded amounts) Any additional procedures performed (and the results of those procedures) to investigate unexpected differences from that comparison

Aggregated Misstatements—The auditor must document:

The nature and effect of misstatements that the auditor aggregates The auditor's conclusions as to whether the aggregated misstatements are material to the financial statements

Definition of Audit Documentation

This is the record of audit procedures performed, relevant audit evidence obtained, and conclusions reached (terms such as working papers or work papers are also sometimes used).

PCAOB on Consideration of Materiality in Planning and Performing an Audit The auditor should determine tolerable misstatement for purposes of assessing risks of material misstatement at the

account or disclosure levels.

The auditor should consider the reliability of information used, but the auditor is not normally responsible for _________. The auditor should obtain evidence about the accuracy and completeness of information used to perform further audit procedures (either in connection with the actual audit procedure or by testing controls related to the information).

authenticating the entity's documents

Responding to the Assessed Risks of Material Misstatement—The auditor should determine whether management complied with the applicable financial reporting requirements, and whether the methods used to make the fair value accounting estimate are appropriate and are

consistently applied. The auditor should consider the need for specialized skills or knowledge.

If information is identified that contradicts or is inconsistent with the auditor's final conclusions—the auditor should document how the auditor addressed the

contradiction or inconsistency in forming the conclusions.

PCAOB on Supervision of the Audit Engagement Engagement partner responsibilities —"The engagement partner is responsible for the ____ and -________. Accordingly, the engagement partner is responsible for proper supervision of the work of engagement team members and for compliance with PCAOB standards, including standards regarding using the work of specialists, other auditors, internal auditors, and others who are involved in testing controls."

engagement and its performance

All significant findings or issues must be identified in an _______in sufficient detail so that a reviewer can obtain a thorough understanding of the matters.

engagement completion document

Revisions—Any revisions to audit documentation after the date of the auditor's report should comply with the following requirements: Documentation Completion Date—T

he auditor should complete the assembly of the final audit file no later than 60 days after the report release date. The PCAOB specifies a limit of 45 days for audits of public companies.

Subsequently Discovered Facts Known Before the Report Release Date—Subsequently discovered facts that became known to the auditor before the report release date The auditor should discuss the matter with________ . If so, the auditor should inquire as to how management will address the matter.

management (and possibly those charged with governance) and determine whether the financial statements require revision

Intercompany Accounts —The auditor should address the risks of _____ misstatement regarding the company's intercompany accounts.

material

PCAOB on Audit Planning "Planning the audit includes establishing the _____ AND ____, which includes, in particular, planned risk assessment procedures and planned responses to the risks of material misstatement. Planning is not a discrete phase of an audit but, rather, a continual and iterative process that might begin shortly after (or in connection with) the completion of the previous audit and continues until the completion of the current audit.

overall audit strategy for the engagement and developing an audit plan

An example of an indicator of possible management bias would be the use of an entity's

own assumptions for fair value accounting estimates that are inconsistent with observable market conditions.

To corroborate management's responses to the auditor's inquiries about the identity of lawyers who have rendered significant legal services to the client (and to whom a letter of inquiry should be sent)—the auditor should examine the charges to the

related expense account and then examine (vouch to) the appropriate underlying invoices.

Evaluation of Financial Statement Treatment —The auditor should evaluate whether the company has properly identified its

related parties and transactions with related parties.

Implications of Going Concern Issues for the Auditor's Report Prohibited the inappropriate use of conditional language—The SAS prohibits using "conditional language" in expressing a conclusion about the existence of _____; for example, the SAS offered the following as inappropriate: "The Company has been unable to renegotiate its expiring credit agreements. Unless the Company is able to obtain financial support, there is substantial doubt about its ability to continue as a going concern."

substantial doubt

he auditor should "maintain control over the confirmation requests and responses." If the response is by fax, the auditor should consider a direct call to the respondent; and if the response is verbal, encourage a _____ reply.

written

Further Substantive Procedures to Respond to Significant Risks—The auditor should evaluate how management addressed estimation ____; whether management's significant assumptions are ___; and, when ______, whether management has the intent and ability to carry out specific actions.

Uncertainty, reasonable & relevant

PCAOB Auditing Standard No. 14, Evaluating Audit Results [AS _____]

2810

Price earnings ratio (P-E ratio) =

Market price of stock/earnings per share

Dating the Auditor's Report—Applicable to subsequent events, as well as to subsequently discovered facts involving the auditor or the predecessor auditor. Dating the Auditor's Report—The auditor's report should not be dated earlier than the date on which the auditor has obtained _______

-"sufficient appropriate audit evidence to support the opinion."

PCAOB Auditing Standard No. 13, The Auditor's Responses to the Risks of Material Misstatement [AS ____]

2301

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU 580, Written Representations. This pronouncement states that the auditor's objectives are

"To obtain written representations from management that they believe they have fulfilled their responsibility for the preparation and fair presentation of the financial statements and for the completeness of information provided to the auditor; Support other audit evidence relevant to the financial statements by means of written representations determined necessary by the auditor; and Respond appropriately to written representations provided by management ... or if management ... (does) not provide the written representations requested by the auditor."

Management's Responsibility for the Evaluation of Going Concern Issues FASB requires management to evaluate whether substantial doubt exists within one year of the issuance of the financial statements; GASB has a similar requirement for governmental entities. Financial statements are prepared using the "going concern basis of accounting" unless the "____________is appropriate.

"liquidation basis of accounting"

Professional judgment is required for "reasonable assurance," and the auditor does not examine all available evidence. The auditor may appropriately consider the cost of information relative to its usefulness, although cost alone is not a valid basis for omitting an audit procedure. Audit evidence is usually _____ an d is rarely_____. The auditor should not be satisfied with evidence that is less than persuasive

"persuasive" (or suggestive) and is rarely "conclusive" (or compelling)

A more significant difference involves the treatment of "assertions" in their respective standards dealing with the topic of audit evidence—the PCAOB focuses on the five traditional financial statement assertions (as presented in an earlier SAS that has since been superseded in an attempt to align U.S. auditing standards more closely with international standards); the resulting current AICPA standard classifies 13 assertions into three categories:

(1) account balances at the period end (for which there are four assertions); (2) transactions and events for the period (for which there are five assertions); and (3) presentation and disclosure (for which there are four assertions).

PCAOB Auditing Standard No. 43 addresses accounting estimates, including fair value measurements. PCAOB AS § 2501 (Auditing Accounting Estimates, Including Fair Value Measurements) replaces three previous PCAOB standards separately dealing with ___ ___ & ____

(1) accounting estimates, (2) fair value measurements, and (3) derivative instruments.

PCAOB on Audit risk The auditor should assess the risks of material misstatement at two levels:

(1) at the financial statement level (where the risk of material misstatement is pervasive and potentially involves many assertions); and (2) at the assertion level (where the risk of material misstatement involves inherent risk and control risk).

Identification of significant assumptionsSignificant assumptions—Those that are important to the recognition or measurement of the accounting estimate.Examples that usually would be considered significant assumptions—Assumptions that are

(1) sensitive to variation, (2) susceptible to manipulation or bias, (3) involve unobservable data, or (4) depend on the company's intent and ability to carry out specific actions.

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement" There are two categories of audit procedures performed in response to the assessed risks of material misstatement:

(1) tests of controls; and (2) substantive procedures.

Rate of return on common stockholders' equity =

(Net income - Dividends attributable to preferred stockholders)/Average common stockholders' equity

Earnings per share =

(Net income - Preferred dividends)/Average number of common shares outstanding

gross profit percentage=

(Sales - Cost of goods sold)/Sales

Subsequent Events—Dating the auditor's report when a subsequent event occurs after the completion of fieldwork but prior to the issuance of the auditor's report If the financial statements are__________(using one date for the overall audit report and a later date to address a specific subsequent event) or the entire audit report may be dated as of the later date (which makes the auditor responsible, in general, for all subsequent events up to that later date).

(a) adjusted along with additional footnote disclosure; or (b) disclosure is added without adjustment—the audit report may be either "dual dated"

The Auditor's Responsibilities Under the SAS The auditor should also inquire about (and perform other risk assessment procedures) to obtain an understanding of the applicable controls established to

(a) identify and account for such related-party relationships and transactions; (b) authorize and approve significant transactions with related parties, as well as those that are outside the normal course of business. (The risk of management override of controls is higher when management has significant influence with parties with whom the entity does business.)

PCAOB on "Identifying and Assessing Risks of Material Misstatement" These risk assessment procedures should include

(a) obtaining an understanding of the company and its environment; (b) obtaining an understanding of internal control over financial reporting; (c) considering information from the client acceptance/retention evaluation, planning activities, prior audits, and other engagements for the company; (d) performing analytical procedures; and (e) inquiring of the audit committee, management, and others within the company about the risks of material misstatement.

Determine whether uncorrected misstatements are material—The auditor should consider

(a) the size and nature of the misstatements; and (b) the effect of uncorrected misstatements related to prior periods.

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement" The auditor should consider (a) making appropriate assignments of responsibilities based on capabilities of team members; (b) providing appropriate supervision; (c) incorporating a degree of unpredictability in planned procedures; ____ & ____

(d) evaluating the company's selection and application of significant accounting principles (especially in subjective areas); and (e) determining whether it is necessary to make pervasive changes to the nature, timing, and extent of audit procedures.

Circumstances affecting the evaluation of materiality include the following: (a) compliance and regulatory requirements; (b) debt covenants; (c) the effect on future periods' financial statements; (d) the effects on changes in earnings (such as changing income to a loss or vice versa) or other trends; (e) the impact on ratios; (f) the effects on segment information; ____ ____ & ____

----, (g) an effect that increases management compensation; (h) the omission of information important to users' understanding; and (i) the misclassification between operating⁄non-operating items or recurring⁄non-recurring items.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis identify the conditions or events that would raise substantial doubt. These procedures include performing substantive analytical procedures, reviewing for subsequent events, reviewing the entity's compliance with requirements of its debt agreements (regarding breach of contract matters that could accelerate the due date of the debt), reading the minutes of meetings of those charged with governance, and sending a letter of inquiry to the entity's attorney(s) to request a _____regarding litigation issues.

-lawyer's letter r

The auditor should document the following three matters in the audit documentation: (

1) the amount below which misstatements would be viewed as clearly trivial ; (2) all misstatements accumulated during the audit and whether they have been corrected; and (3) the auditor's conclusion (and the basis for that conclusion) about whether the uncorrected misstatements are material, individually or in the aggregate.

PCAOB Auditing Standard No. 8, Audit Risk [AS ______]

1101

PCAOB Auditing Standard No. 15, Audit Evidence [AS _____]

1105

PCAOB Auditing Standard No. 10, Supervision of the Audit Engagement [AS _____]

1201

PCAOB Auditing Standard No. 9, Audit Planning [AS ____]

2101

PCAOB Auditing Standard No. 11, Consideration of Materiality in Planning and Performing an Audit [AS ______]

2105

PCAOB Auditing Standard No. 12, Identifying and Assessing Risks of Material Misstatement [AS _____]

2110

PCAOB Auditing Standard No. _____ addresses accounting estimates, including fair value measurements. PCAOB AS § 2501 (Auditing Accounting Estimates, Including Fair Value Measurements) replaces three previous PCAOB standards separately dealing with (1) accounting estimates, (2) fair value measurements, and (3) derivative instruments. It was approved by the SEC in July 2019 and is effective for audits for fiscal years ending on or after December 15, 2020.

43

A complete and final set of audit documentation should be assembled no later than _____ days after the report release date—That is called the documentation completion date. (Recall that the AICPA allows auditors of nonissuers to have a maximum of 60 days for this purpose.)

45

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU ____, Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures. This pronouncement states that the auditor's objective is to obtain sufficient appropriate audit evidence about whether the accounting estimates (including fair value accounting estimates) are reasonable and whether the related disclosures are adequate in view of the applicable financial reporting framework.

540

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU ______, Auditing Accounting Estima tes, Including Fair Value Accounting Estimates and Related Disclosures. This pronouncement states that the auditor's objective is to obtain sufficient appropriate audit evidence about whether the accounting estimates (including fair value accounting estimates) are reasonable and whether the related disclosures are adequate in view of the applicable financial reporting framework.

540

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU _____, Written Representations. This pronouncement states that the auditor's objectives are "To obtain written representations from management that they believe they have fulfilled their responsibility for the preparation and fair presentation of the financial statements and for the completeness of information provided to the auditor; Support other audit evidence relevant to the financial statements by means of written representations determined necessary by the auditor; and Respond appropriately to written representations provided by management ... or if management ... (does) not provide the written representations requested by the auditor."

580

Must retain audit documentation for ______ years from the report release date—The report release date is when the auditor grants permission to use the auditor's report in connection with the issuance of the company's financial statements. (Recall that the AICPA requires a retention period of five years for audits of nonissuers. )

7

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU 230, Audit Documentation. This pronouncement states that the auditor's objective is "to prepare documentation that provides:

A sufficient and appropriate record of the basis for the auditor's report; and Evidence that the audit was planned and performed in accordance with (GAAS) and applicable legal and regulatory requirements."

AICPA Professional Standards now classify assertions in three separate categories for the auditor's consideration, related to: Account balances; Presentation and disclosure; and Classes of transactions and events.

Account balances; Presentation and disclosure; and Classes of transactions and events.

_________The records of initial accounting entries and supporting records, such as checks and records of electronic fund transfers, invoices, contracts, the general and subsidiary ledgers, journal entries and other adjustments to the financial statements that are not reflected in journal entries, and records, such as work sheets and spreadsheets, supporting cost allocations, computations, reconciliations and disclosures.

Accounting Records

Additional Guidance Regarding Estimation UncertaintyNature of Estimation Uncertainty—The nature of estimation uncertainty varies with the nature of the _______, the extent to which there is an accepted method (or model) to be used, and the subjectivity of any assumptions or the degree of judgment involved. The risks of material misstatement increase when there is high estimation uncertainty.

Accounting estimate

______ An approximation of a monetary amount in the absence of a precise means of measurement. Auditor's Point Estimate (or Auditor's Range): The amount (or range of amounts) derived from audit evidence for use in evaluating the recorded or disclosed amount(s).

Accounting estimate

There are five assertions about "classes of transactions and events during the period."

AccuracyThat amounts and other data have been recorded appropriately. OccurrenceThat transactions and events that have been recorded have occurred. In other words, they are properly recorded and valid. CompletenessThat all transactions and events that should have been recorded have been recorded. There are no omissions. CutoffThat transactions and events have been recorded in the correct accounting period. Note that there are only two ways to record a transaction in the wrong period. One is by recording a transaction prematurely, which violates the "occurrence" assertion; and the other is to record a transaction belatedly, which violates the "completeness" assertion. ClassificationThat transactions and events have been recorded in the proper accounts.

The auditor's substantive procedures should include the following related to the financial reporting process:

Agree the financial statement information to the underlying accounting records. Examine material journal entries and other adjustments made during the preparation of the financial statements.

Definition of external confirmation

Audit evidence obtained as a direct written response to the auditor from a third party ("the confirming party"), either in paper form or by electronic or other medium (e.g., through the auditor's direct access to information held by a third party).

Current Year's Audit Files—The current year's audit files include the auditor's documentation of important administrative matters (such as the audit team's time budget) along with the supporting working papers related to the financial statement items.

Audit plan (sometimes called the audit program). Memoranda (documenting planning activities, consideration of fraud, assessment of internal control, etc.). Abstracts or copies of relevant client documents (including minutes of board of directors' meetings or meetings of those charged with governance). Letters (confirmations, attorney letters, management representation letter, engagement letter, etc.). Analyses and schedules (either prepared by client personnel or by the audit team).

PCAOB on Audit planning- The ____—Deals with the planned nature, timing, and extent of the risk assessment procedures, the tests of controls, the substantive procedures, and any other procedures required to comply with PCAOB standards.

Audit plan—

Audit Documentation—Should document the following:The conditions or events causing the auditor to have substantial doubt for a reasonable period of time; Elements of management's plans considered to be significant in mitigating those conditions or events; Audit procedures performed (and results obtained) to evaluate the significant elements of management's plans; ____ & ____

Auditor's conclusion as to whether the substantial doubt remains or is alleviated and the evaluation of the adequacy of related disclosures; and Auditor's conclusion with respect to the effects on the auditor's report.

What are the basic document requirements?

Basic Documentation Requirement—(1) Demonstrate that the engagement complied with PCAOB standards; (2) support the basis for the auditor's conclusions regarding every relevant financial statement assertion; and (3) demonstrate that the underlying accounting records agree to or reconcile with the financial statement elements.

The Auditor's Responsibilities Under the SAS If the auditor identifies related-party transactions not previously disclosed by management—The auditor should:

Communicate relevant information to members of the engagement team Ask management to identify all transactions with the newly identified related party Inquire about why the entity's controls did not identify the related-party relationship Perform appropriate substantive audit procedures Reconsider the risk that there may be other undisclosed related-party relationships Evaluate whether management's failure to disclose the matter might have been intentional

The Auditor's Responsibilities Under the SAS Examples of transactions outside the normal course of business

Complex equity transactions (restructctions or acquisitions)Transactions with offshore entities Sales transactions with unusually large discounts Transactions with circular arrangements (such as repurchase agreements)

The Auditor's Responsibilities Under the SAS When there is a significant risk about related-party transactions—The auditor may perform substantive procedures such as the following:

Confirm specific terms of the transactions with the related parties Inspect evidence in the possession of the entity or the related party Confirm (or discuss) information with intermediaries, such as banks or others Review audited financial statements, income tax returns, or reports issued by regulatory agencies to assess the financial condition of the other party

Types of Files Related to Audit Working Papers Permanent File—Involves matters having ongoing audit significance and may include:

Description of the client's industry, a brief history of client, and a description of the client's facilitiesAbstracts or copies of important legal documents and important long-term contracts—documents such as the company's articles of incorporation and bylaws and contracts such as debt agreements, leases, and labor contracts (including pension plans and profit- sharing agreements)Documentation of the auditor's understanding of internal control for the major transaction cyclesHistorical financial information—Such as ratio analysis of the client's operations or other data having ongoing usefulness

Responding to the Assessed Risks of Material Misstatement The auditor should determine whether management has complied with the requirements of the applicable financial reporting framework, and whether the methods used to make the estimate are appropriate and consistently applied. In responding to the assessed risks, the auditor should do one (or more) of the following:

Determine whether events occurring up to the date of the auditor's report provide evidence about the accounting estimate;Test how management made the estimate, along with the data used;Test the operating effectiveness of applicable controls, along with performing appropriate substantive procedures; and/orDevelop a point estimate (or range) to evaluate management's point estimate. The auditor should consider the need for specialized skills or knowledge.

Definition of Subsequent Events:

Events occurring between the date of the financial statements and the date of the auditor's report.

Reliability" is affected by the source and nature of evidence and depends upon individual circumstances however, the SAS offers the following guidelines:

Evidence obtained directly by the auditor is more reliable than evidence obtained indirectly or by inference (e.g., observation of the application of a control is more reliable than inquiry of entity personnel about the application of a control). Evidence is more reliable when obtained from independent (knowledgeable) sources outside the entity; Evidence generated internally is more reliable when the related controls are effective; Evidence is more reliable when it exists in documentary form (whether paper or electronic); and Evidence provided by original documents is more reliable than evidence based on photocopies/facsimiles (faxes).

Historically, the auditing standards discussed five traditional financial statement assertions:

Existence/occurrence; Completeness; Rights and obligations; Valuation and allocation; and Presentation and disclosure.

There are four assertions specific to "account balances at period end"

ExistenceThat the assets, liabilities, and equity interests exist. CompletenessThat all assets, liabilities, and equity interests that should have been recorded have been recorded. There are no omissions. Rights and obligationsThat the entity holds or controls the rights to its assets, and the liabilities are the obligations of the entity. Any restrictions on the rights to the assets or obligations for the liabilities must be disclosed. Valuation and allocationThat assets, liabilities, and equity interests are included in the financial statements at appropriate amounts (relative to the requirements of GAAP) and any resulting valuation or allocation adjustments are appropriately recorded.

PCAOB on Consideration of Materiality in Planning and Performing an Audit The auditor should use the same materiality considerations for planning the audit of internal control over financial reporting as for the audit of the ___

FS

Accumulation of Identified Misstatements—The auditor should accumulate all misstatements identified during the audit (except for those that are clearly trivial , which means inconsequential). The auditor may wish to distinguish among the following three types of misstatements:

Factual misstatements—Misstatements for which there is no doubt. Judgmental misstatements—Differences due to the judgments of management that the auditor considers unreasonable or to the selection of accounting policies that the auditor views as inappropriate. Projected misstatements—The auditor's best estimate of misstatements in populations as suggested by audit sampling.

Perform Risk Assessment Procedures—The auditor should perform procedures to obtain an understanding of the nature of the relationships between the company and its related parties, including the terms and business purposes of transactions with related parties. The auditor should obtain an understanding of the company's process for

Identifying related parties and transactions with related parties; Authorizing and approving transactions with related parties; and Accounting for and disclosing relationships and transactions with related parties in the financial statements.

If a Predecessor Auditor Reissues the Auditor's Report If a Subsequently Discovered Fact Becomes Known to the Predecessor

If management revises the financial statements and the predecessor auditor plans to issue a new auditor's report—the predecessor should: Perform the procedures necessary to evaluate the revision (and date the audit report appropriately or dual-date the report for the revision); Assess steps taken by management to ensure that users do not rely on the erroneous financial statements; and If the opinion on the revised financial statements differs from that previously expressed, add an emphasis-of-matter or other matter paragraph

Other Information Constituting Audit Evidence: ______

Includes minutes of meetings, confirmations, industry analysts' reports, internal control manuals, and any other information obtained by inquiry, observation, and inspection.

Times interest earned =

Income before interest expense and income taxes/Interest expense

Definition of Audit Evidence

Information used by the auditor in arriving at the conclusions on which the auditor's opinion is based. Audit evidence includes both information contained in the accounting records underlying the financial statements and other information.

Audit Risk=

Inherent risk X control risk X detection risk

If the auditor determines that previously undisclosed related-party relationships or transactions exist, the auditor should do the following:

Inquire of management about the possible existence of other transactions with the related party previously undisclosed; Evaluate why the matter was previously undisclosed to the auditor; Communicate relevant information to other members of the audit team; Consider the need to perform additional procedures to identify other relationships or transactions previously undisclosed; Perform the procedures identified above for transactions with related parties required to be disclosed or determined to be a significant risk; and Reconsider the auditor's risk assessment:

The Auditor's Responsibilities Under the SAS Procedures to obtain an understanding of the business relationships involving a related party (and to determine the need for further substantive procedures) include the following:

Inquiries of management and those charged with governance Inquiries of the related parties Inspection of contracts with the related party Review of employee whistleblowing reports, if available Background research, perhaps using the Internet

The auditor may use computer-assisted audit techniques (CAATs) to assist the auditor when information is in electronic form:

Inspection of records/documents Inspection of tangible assets Observation Inquiry Confirmation Recalculation Reperformance Anlytical procedures

An unasserted claim must be disclosed according to GAAP if the following two conditions exist:

It is probable that a claim will be asserted, andIt is at least reasonably possible that a material unfavorable outcome will occur.

______ is the primary source of information about these legal contingencies. The auditor should make appropriate inquiries of management.

Management

_____ The amount selected by management for recognition or disclosure as an accounting estimate.

Managements point estimate

Going concern issues might be indicated by the following circumstances:

Negative financial trends—Recurring operating losses, negative cash flow from operations, adverse financial ratios, etc. Other indications—Already in default, entity is denied usual trade credit, cash dividends are in arrears, the entity is selling pieces its business, etc. Internal matters—Facing work stoppages, dependence on a particular project or customer, etc. External matters—Uninsured casualty losses, significant litigation, changing technology, etc.

Current Cash to debt ratio=

Net cash from operations/Average current liabilities

Cash to debt coverage ratio =

Net cash from operations/Average total liabilities

Rate of return on assets =

Net income/Average total assets

Asset Turnover=

Net sales/Average total assets

Receivable turnover=

Net sales/average trade receivable

lawyers must tell their client about any such ______ and request that client management then inform the auditors.

OMMISSIONS

For fair value accounting estimates, assumptions (inputs) affect estimation uncertainty and vary as follows: Observable inputs— Unobservable inputs—

Observable inputs—Assumptions that market participants would use in pricing an asset or liability based on market data from sources independent of the reporting entity or Unobservable inputs—An entity's own judgments about what assumptions market participants would use. Estimation uncertainty increases when the fair value estimates are based on unobservable inputs.

There are four assertions about "presentation and disclosure."

Occurrence and rights and obligationsThat the disclosed events and transactions have occurred and pertain to the entity. CompletenessThat all disclosures that should have been included have been included. There are no omissions of required disclosures. Classification and understandabilityThat financial information is appropriately presented, described, and clearly expressed. Accuracy and valuationThat financial and other information are disclosed fairly and at appropriate amounts.

The Auditor's Responsibilities Under the SAS Examples of arrangements that may indicate undisclosed related-party relationships

Participation in partnerships with other parties Agreements with other parties having conditions outside the normal course of business Guarantees involving other parties

Subsequently Discovered Facts Known After the Report Release Date If Management Revises the Financial Statements—The auditor should

Perform appropriate audit procedures on the revision; Assess whether management's actions are timely and appropriate to ensure that users are informed; and If the opinion on the revised financial statements differs from that previously expressed; add an emphasis-of-matter or other matter paragraph (that identifies the date of the previous report, the opinion previously expressed, and the reason for the different opinion now expressed).

ailor Objectives/Assertions—The auditor should tailor the confirmations to the specific audit objectives/assertions. Confirmations are most useful in addressing the existence/occurrence assertion. There are two basic types of confirmation requests:

Positive confirmation request and Negative confirmation request

What is the purpose of audit documentation?

Provides the principal support for the auditor's report (regarding the procedures performed and the conclusions reached). Documents the auditor's compliance with GAAS and any applicable legal and regulatory requirements; The audit documentation assists in controlling the audit work—that is, breaking the overall audit project into manageable tasks that can be delegated to the various members of the audit team

If a Predecessor Auditor Reissues the Auditor's Report The predecessor should perform the following procedures to determine whether the previously issued auditor's report is still appropriate

Read the financial statements of the subsequent period (and compare those financial statements with the ones previously audited and reported on to identify any significant changes); Inquire of and request written representations from management about any issues, including subsequent events, that might affect the previous representations from management; and Obtain a representation letter from the successor auditor about any known matters affecting the financial statements audited by the predecessor.

The auditor should respond appropriately to the assessed risks of material misstatement associated with related parties and transactions with related parties. For any related-party transactions that are required to be disclosed or that are determined to be a significant risk, the auditor should do the following:

Read the underlying documents for consistency with explanations from inquiries and other audit evidence about the business purpose; Determine whether the transaction has been authorized and approved in accordance with the company's established policies and whether any exceptions to the company's established policies were granted; Evaluate the financial capability of the related parties with respect to significant responsibilities (relevant information might include the audited financial statements of the related parties, reports of regulatory agencies, financial publications, and income tax returns if available); and Perform other procedures as necessary regarding the assessed risks of material misstatement.

________"The period of time required by the applicable financial reporting framework or, if no such requirement exists, within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable)."

Reasonable period of time

Alternative Procedures—Alternative (sometimes called "alternate") audit procedures are usually required when no response is received for a positive confirmation request:

Receivables—The auditor would first look to see whether cash was received subsequent to the date of the confirmation request. Second best, the auditor would examine the documents underlying the apparent validity of the recorded transaction. Payables—The auditor would usually verify subsequent cash disbursements as evidence of payment of the account

The auditor should also communicate other significant matters associated with related-party relationships and transactions, such as the following:

Related-party relationships or transactions with parties that were previously undisclosed to the auditor Significant related-party transactions that have not been authorized in accordance with the company's established policies or for which exceptions to the company's established policies were made Related-party transactions identified by the auditor that appear to lack an appropriate business purpose Management's assertion included in the financial statements that the terms of a related-party transaction were equivalent to that of an arm's-length transaction (and the evidence obtained by the auditor that is consistent or inconsistent with that assertion)

Evaluating the reasonableness of significant assumptions—The auditor should determine whether the company has a reasonable basis for significant assumptions used and whether the significant assumptions are consistent with the following, when applicable:

Relevant industry and other external factors, including economic factors The company's objectives, strategies, and business risks External market informationRelevant historical or recent experience Other significant assumptions used by the company in other estimates tested by the auditor

Auditor's Evaluation of Management's Evaluation and Supporting Analysis When conditions or events are identified that raise substantial doubt—Should perform additional audit procedures, including consideration of any mitigating factors

Request that management make an evaluation if they have not already done so. Evaluate whether management's plan as to whether it is probable that the plans can be implemented and would effectively mitigate the conditions or events that raise the going concern issue. When financial support by "supporting parties" (either third parties or the entity's owner-manager) are important to management's plans—Should obtain sufficient appropriate audit evidence (specifically, in writing) about the supporting parties' intent and ability of those parties to provide the necessary support. When the analysis of the entity's cash flow forecast is significant to management's plans—Should evaluate the reliability of the underlying data and the adequacy of the support for the underlying assumptions.

Overview of PCAOB's Standard on Auditing Accounting Estimates

Requires auditors to give greater attention to potential management bias involving accounting estimates Extends key requirements in the fair value standard to other significant accounting estimates to achieve a more uniform approach to substantive testing Integrates requirements with the PCAOB's risk assessment standards to emphasize estimates having greater risk of material misstatement Updates other requirements related to auditing accounting estimates Provides more specific requirements when auditing the fair value of financial instruments

Audit Procedures Regarding Subsequent Events Inquire of Management—Include an appropriate reference to such subsequent events in the management representations letter. The auditor should also obtain an understanding of management's procedures to identify subsequent events, as appropriate. _____, ___ & ____`

Review the minutes of meetings of those charged with governance. (Include all meetings up to the date of the audit report.) The lawyer's letter may be relevant to this issue (regarding legal contingencies). Scan journals and ledgers subsequent to year-end (through fieldwork) for any unusual items.

The Auditor's Responsibilities Under the SAS The auditor should stay alert for any indications of related-party relationships or transactions that management has failed to disclose to the auditor. The auditor should be attentive to such matters when

Reviewing bank confirmations and other records or documentsReading the minutes of meetings of those charged with governance

In obtaining an understanding of whether and how management has assessed estimation uncertainty, the auditor might consider whether management has performed a ______ analysis and monitors outcomes of prior accounting estimates.

Sensitivity

Must document all ______ findings or issues (also document the actions taken to address them and the basis for the conclusions reached)—Including the application of accounting principles, circumstances causing modification of planned audit procedures, matters that could result in modification of the auditor's report, material misstatements, significant deficiencies or material weaknesses in internal control over financial reporting, difficulties in applying audit procedures, and disagreements among members of the engagement team about final conclusions on significant matters, among other things.

Significant

The auditor should also document audit findings or issues that are significant (including actionstaken to address them and the basis for conclusions reached), and should also document discussions of significant findings or issues with management (including issues discussed, and when and with whom). Such findings and issues include:

Significant matters regarding the selection, application, and consistency of accounting principles Circumstances causing difficulty in applying necessary audit procedures Results of audit procedures indicating a possible material misstatement Findings that could result in modification of the audit report Audit adjustments (whether or not recorded by management) that could have a material effect individually or when aggregated

The Specific Content of the Representations Depend on the Circumstances Regarding the Information Provided:

That all relevant financial records and unrestricted access to personnel were made available to the auditor That all transactions have been recorded That management has made available the results of their assessment of fraud risks That regarding fraud, there is no fraud involving management or employees having significant internal control responsibilities, or others where the financial statement effect could be material That management has no knowledge of suspected fraud communicated by employees, former employees, or others That management has disclosed all instances of noncompliance with laws and regulations relevant to financial reporting That there are no (undisclosed) litigations, claims, and assessments relevant to the financial statements That management has disclosed all known related party relationships and transactions

The Specific Content of the Representations Depend on the Circumstances— Usually include the following provisions as applicable. Regarding the Financial Statements:

That management is responsible for the fairness of the financial statements That management is responsible for internal control over financial reporting That management is responsible for internal control to prevent and detect fraud That significant assumptions used for any accounting estimates are reasonable That related party transactions have been properly accounted for and disclosed That subsequent events have been properly accounted for and disclosed That any uncorrected misstatements are immaterial That the effects of litigation and claims have been properly accounted for and disclosed

Revisions—Any revisions to audit documentation after the date of the auditor's report should comply with the following requirements: Retention Requirements—

The AICPA requires that the audit documentation be retained for at least five years from the report release date. (The PCAOB requires retention for at least seven years for audits of public companies.)T

Definition of risk assessment procedures

The audit procedures performed to obtain an understanding of the entity and its environment, including the entity's internal control, to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and relevant assertion levels.

Revisions—Any revisions to audit documentation after the date of the auditor's report should comply with the following requirements: Before the Documentation Completion Date—

The auditor may add information received after the report date or delete unnecessary documentation up to the documentation completion date.

Revisions—Any revisions to audit documentation after the date of the auditor's report should comply with the following requirements:After the Documentation Completion Date—

The auditor must not delete any audit documentation before the end of the retention period; the auditor may add to the documentation, but must document any materials added, by whom, when, reasons for the change, and the effect, if any, on the auditor's conclusions.

NOTE:

The auditor should obtain audit evidence by testing the accounting records, by analysis, review, and reconciling related information; however, the accounting records by themselves do not provide sufficient appropriate audit evidence.

Going-Concern Issues—The auditor must document:

The conditions giving rise to the going concern issue The elements of management's plan considered important to overcoming the situation Evidence obtained to evaluate the significant elements of management's plans The auditor's conclusion as to whether substantial doubt remains The auditor's conclusion as to whether an explanatory paragraph should be added to the auditor's report

FASB definition of related parties :

The essence of this definition is that one party has the ability to influence the conduct of the other party.

The Auditor's Responsibilities Under the SAS The auditor should inquire of management about

The identity of the entity's related parties The nature of the relationships involved Whether the entity engaged in any transactions with those related parties during the period, and, if so, the purpose of the transactions

The auditor should make appropriate inquiries of management, others who may be knowledgeable about related-party issues, and the audit committee (or chair).Inquire of management about the following:

The names of the company's related parties, the nature of the relationships, and any changes from the prior period; Background information about the related parties, including location, industry, size, etc.; The transactions involving related parties during the period, including the terms and business purposes of those transactions; and Any related-party transactions that were not authorized according to the company's established policies (including any exceptions that were granted and the reasons).

AICPA Requirements Audit documentation should permit an experienced auditor without prior connection to the audit to understand the following:

The nature, timing, and extent of procedures performed;The results of those procedures;The conclusions reached on significant matters; andWhether the accounting records agree or reconcile with the audited financial statements.

Responding to Risks of Material Misstatement—AU 330, Performing Audit Procedures in Response to Assessed Risks and Evaluating the Audit Evidence Obtained, states, "The auditor should use external confirmation procedures for accounts receivable, except when one or more of the following is applicable:

The overall account balance is immaterial. External confirmation procedures for accounts receivable would be ineffective. The auditor's assessed level of risk of material misstatement at the relevant assertion level is low, and the other planned substantive procedures address the assessed risk. In many situations, the use of external confirmation procedures for accounts receivable and the performance of other substantive procedures are necessary to reduce the assessed risk of material misstatement to an acceptably low level."

Documentation—As covered in the course materials on internal controls, the auditor should document the following matters:

The overall responses to address the assessed risk of misstatement at the financial statement level The nature, timing, and extent of the further audit procedures The linkage of those procedures with the assessed risks at the relevant assertion level; The results of the audit procedures The conclusions reached in the current audit about the operating effectiveness of controls tested in a prior audit

The auditor may justify using negative confirmations when:

The population consists of a large number of small, rather homogeneous items;The assessed risk of material misstatement is low, and the relevant controls are operating effectively; andRecipients are expected to pay attention to the request, and a low rate of exceptions is expected

PCAOB on "Evaluating Audit Results"The auditor should consider all relevant audit evidence (whether it corroborates or contradicts the financial statements) and evaluate the following

The results of analytical procedures performed as the overall review Misstatements (other than "trivial" ones) accumulated during the audit (with emphasis on uncorrected misstatements) The qualitative aspects of the company's accounting practices, including potential for management bias Conditions identified related to fraud risk The presentation of the financial statements (including disclosures) relative to the applicable financial reporting framework The sufficiency and appropriateness of the evidence obtained

Quantity of Content—The quantity, type, and content of the audit documentation depends on the auditor's professional judgment and may include consideration of the following matters:

The risk of material misstatement in the area involved The amount of judgment involved in performing the work and interpreting the results (including the nature of the audit procedures involved) The nature and extent of any exceptions identified The significance of the evidence to the assertion involved The need to document a conclusion not readily determinable from the documentation of the work performed

The sufficiency and appropriateness of audit evidence as a basis for the auditor's conclusions are matters of professional judgment. The auditor's judgment may be influenced by factors such as the following:

The significance of the potential misstatement and the likelihood that it may have a material effect The understanding of the entity and its environment, including internal control The effectiveness of management's responses and controls to address the risks The results of the audit procedures performed (including whether the procedures identified instances of fraud or error) The persuasiveness of the audit evidence obtained The source and reliability of available information The experience gained in previous audits with such misstatements

Using Pricing Information from Multiple Pricing Services—Less information is required when the following conditions are met:

There are recent trades of identical or similar financial instruments.The type of financial instrument is routinely priced by several pricing services.Prices are reasonably consistent across the various pricing services.The pricing information is based on inputs that are observable.

Analytical procedures serve three distinct purposes

They are useful as a risk assessment procedure for planning purposes They are useful as a form of substantive evidence The auditor is required to perform analytical procedures near the end of the audit to assist the auditor when forming an overall conclusion about the financial statements

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement" What is the auditors objective

To address the risks of material misstatement through appropriate overall audit responses and audit procedures.

PCAOB on Consideration of Materiality in Planning and Performing an Audit. What is the auditors objective?

To apply the concept of materiality appropriately in planning and performing audit procedures

PCAOB on "Evaluating Audit Results" What is the auditors objective?

To evaluate the results of the audit to determine whether the audit evidence obtained is sufficient and appropriate to support the opinion.q

The relevant AICPA guidance is provided by the clarified SAS, AU-C 550, Related Parties. This pronouncement states that the auditor's objectives are:

To obtain an understanding of related-party relationships and transactions to address fraud risk factors and evaluate whether the financial statements achieve fair presentation and To obtain sufficient appropriate audit evidence about whether related-party relationships and transactions are properly accounted for and adequately disclosed in the financial statements.

Responsibilities under AICPA Professional Standards—The relevant AICPA guidance is provided by AU 560, Subsequent Events and Subsequently Discovered Facts. This pronouncement states that the auditor's objectives are

To obtain sufficient appropriate audit evidence about whether subsequent events are properly reflected in the financial statements; To respond appropriately to subsequently discovered facts; and For a predecessor auditor who is requested to reissue a previously issued report, to perform specified procedures to determine whether the previously issued report is still appropriate.

Responsibilities Under AICPA Professional Standards—The relevant AICPA guidance is provided by AU-C 570, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern. This pronouncement identifies the following audit objectives:

To obtain sufficient appropriate audit evidence whether management's use of the going concern basis of accounting is appropriate when used in the preparation of the financial statements; To conclude whether substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time exists; To evaluate the possible financial statement effects (including disclosure) regarding the entity's ability to continue as a going concern for a reasonable period of time; and To report appropriately in accordance with this SAS.

PCAOB on "Audit Evidence" Auditors objective

To plan and perform the audit to obtain appropriate audit evidence that is sufficient to support the opinion.

Debt to total assets ratio =

Total liabilities/Total assets

Debt to equity ratio =

Total liabilities/Total stockholders' equity

Auditor Conclusions—The auditor should reach a conclusion about the following:

Use of the going concern basis of accounting—Should conclude on the appropriateness of management's use of the going concern basis of accounting in the preparation of the financial statements.Substantial doubt—Should conclude on whether there are conditions or events that raise substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time.Adequacy of disclosure—Should conclude whether disclosure is adequate (whether or not substantial doubt has been alleviated by management's plans).

Positive Confirmation Request—Where a response is requested whether or not the other party agrees with the client's recorded amount. A nonresponse is viewed as a "loose end" that must be addressed. 3 things___

When individual accounts are large Requires second (or possibly third) requests as a follow-up procedure for nonresponses If no response is obtained, the auditor must perform alternative procedures.

Evaluating the Use of Models for Fair Value Accounting Estimates—Matters the auditor may consider in testing the model include the following:

Whether the model is validated for suitability prior to usage Whether appropriate controls exist over changes Whether the model is periodically tested for validity (when inputs are subjective) Whether adjustments are made to the model's outputs Whether the model is adequately documented, including key parameters and limitations

The relevance of pricing information used as audit evidence is affected by the following:

Whether the values are based on quoted prices in active markets for identical financial instrumentsWhen the values are based on transactions of similar financial instruments—The auditor should consider how those transactions were determined to be comparable.When no recent transactions have occurred for the financial instrument being valued (or for similar financial instruments)—The auditor should consider whether the inputs used are representative of the assumptions that market participants would use for valuation purposes; the auditor should perform additional procedures to evaluate the appropriateness of the method used by the pricing service.

Communication with Those Charged with Governance— Should include the following in such communication:

Whether there are conditions or events that constitute substantial doubt for a reasonable period of time; Auditor's consideration of management's plans; Whether management's use of the going concern basis of accounting in its financial statements is appropriate; The adequacy of disclosures in the financial statements; and The implications of these going concern issues for the auditor's report.

The office of the firm issuing the auditor's report is responsible for ensuring that all documentation complies with PCAOB requirements—Documentation of other auditors associated with the engagement (in other offices of the firm or in different firms) must be retained or

accessible to the office issuing the report.

Subsequently Discovered Facts Known After the Report Release Date The auditor should discuss the matter with management (and possibly those charged with governance) and determine whether the financial statements require revision. If so, the auditor should inquire as to how management will ______

address the matter.

Implications of Going Concern Issues for the Auditor's Report When the use of the going concern basis of accounting is inappropriate—Should express an_______when liquidation is imminent and management's use of the going concern basis of accounting in inappropriate.If

adverse opinion

If management refuses to correct some (or all) of the misstatements—The auditor should obtain

an understanding of management's reasons and take that into consideration when evaluating whether the financial statements are materially misstated.

Identifying and Assessing Risks of Material Misstatement—The auditor should evaluate the degree of estimation uncertainty involved, and determine whether (Recall that significant risks require the auditor to obtain an understanding of whether relevant controls mitigate such risks.)

any of those accounting estimates result in significant risks.

Evaluating the Reasonableness of the Estimates—The auditor should evaluate whether the fair value accounting estimates are reasonable relative to the requirements of the

applicable financial reporting framework.

One of the "Performance Principles" addresses the importance of obtaining sufficient appropriate audit evidence: "To obtain reasonable assurance, which is a high but not absolute level of assurance, the auditor obtains sufficient ________

appropriate audit evidence about whether material misstatements exist, through designing and implementing appropriate responses to the assessed risks."

For matters documented in a central repository or in a particular office of the public accounting firm (including issues such as auditor independence, staff training, client acceptance/retention, etc.)—The audit documentation should

appropriately reference the central repository.

When the company changed the method used to determine the accounting estimate—The auditor should evaluate the

appropriateness of the change

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement" Responses involving the nature, timing, and extent of audit procedures —The auditor should address the _____of material misstatement for each relevant assertion of each significant account and disclosure.

assessed risks

Scope Limitation—A limitation in the lawyer's response is a scope limitation sufficient to preclude an unmodified opinion (a nonresponse would likely result in a

disclaimer of opinion owing to a major scope limitation).

Written Representations—Should request written representations from management (1) about management's plans intended to mitigate the relevant conditions or events, and (2) whether

disclosure of all relevant matters is appropriate (including the conditions or events involved and management's plans).

Subsequently Discovered Facts—If management revised the financial statements Before the report release date—The auditor should either date the auditor's report as of a later date (and extend the audit procedures to the new date and obtain an updated management representations letter as of the new date) or________ After the report release date (also applicable to a predecessor auditor)—The auditor should date the audit report _________

dual-date the auditor's report for the revision. audit report appropriately or dual-date the report for the revision.

Relationships in a stable environment are usually more predictable than those in a ______ Relationships involving income statement accounts tend to be more predictable than those involving ______(since the income statement deals with a period of time rather than a single moment in time). Relationships involving transactions subject to management discretion tend to be less _______

dynamic environment. balance sheet accounts predictable

PCAOB on Audit Planning Auditor's objective —To plan the audit so that the audit is conducted _____

effectively.

The auditor may decide to test how management made their ______ (and the data used) when the accounting estimate is a fair value accounting estimate using observable and unobservable inputs.

estimate

Estimation Uncertainty: The susceptibility of an accounting

estimate and related disclosures to an inherent lack of precision in its measurement.

Basis for Risk Assessment—The auditor should obtain an understanding of the applicable financial reporting requirements, and how management makes the fair value accounting estimate (and data used), including how management assessed the effect of

estimation uncertainty.

The auditor should communicate all misstatements accumulated during the audit on a timely basis with the appropriate level of management and request they correct the misstatements. The appropriate level is the one that has the authority to

evaluate the misstatements and take necessary action.

The Auditor's Responsibilities Under the SAS If the auditor identifies significant related-party transactions outside the entity's normal course of business—The auditor should determine whether those transactions have been appropriately authorized. The auditor should also inspect any underlying agreements to

evaluate whether the terms are consistent with management's explanations or whether the business rationale might suggest fraud.

Perform Risk Assessment Procedures—Should consider whether conditions or events exist that raise substantial doubt; should determine whether management has performed an ________

evaluation of any such conditions or events.

The historical cost principle in accounting is based on the notion of an ________, which results in an accurate measure of the value exchanged. However, related parties could potentially set the transaction price at whatever value they wish, without regard to the "real" economic value. Auditors are generally not in a position to provide reliable, independent appraisals of transaction prices between related parties. As a result, auditors are particularly concerned with the adequacy of disclosure about transactions between related parties.

exchange price negotiated in an arms-length transaction

Critical accounting estimates Definition: "An accounting estimate where (a) the nature of the estimate is material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change and (b) the impact of the estimate on ___ is material

financial condition or operating performance is material."

The auditor should read the minutes of all meetings of those charged with governance where significant issues, including matters related to legal liability, affecting the ____ likely would be discussed.

financial statement

If a Predecessor Auditor Reissues the Auditor's Report If a Subsequently Discovered Fact Becomes Known to the Predecessor The predecessor auditor should discuss the matter with management (and possibly those charged with governance) and determine whether the_______ If so, the auditor should inquire as to how management will address the matter.

financial statements require revision.

PCAOB on AUdit Risk "Reasonable assurance" means reducing audit risk to an appropriately low level — The auditor must plan and perform the audit to obtain reasonable assurance about whether the financial statements are

free of material misstatements due to error or fraud.

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement"The auditor should perform substantive procedures that are responsive to any

identified significant risks (including fraud risks).

Disclosures—The auditor should obtain sufficient appropriate audit evidence as to whether the disclosures meet the requirements of the applicable financial reporting framework. The auditor should also evaluate the adequacy of disclosure of the estimation uncertainty for any

identified significant risks.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis Procedures to identify conditions or events that raise going concern issues Audit procedures routinely performed in any audit engagement are normally sufficient to identify relevant conditions or events—Need not design specific procedures to

identify the conditions or events that would raise substantial doubt. These procedures include performing substantive analytical procedures, reviewing for subsequent events, reviewing the entity's compliance with requirements of its debt agreements (regarding breach of contract matters that could accelerate the due date of the debt), reading the minutes of meetings of those charged with governance, and sending a letter of inquiry to the entity's attorney(s) to request a lawyer's letter regarding litigation issues. When conditions or events raise substantial doubt—There may be a need for additional audit procedures (e.g., analyzing and discussing the entity's latest interim financial statements or relevant forecasts, determining the adequacy of support for planned disposals of assets, etc.).

More assurance is obtained from consistent audit evidence obtained from different sources or of a different nature ("corroborating" information) than from evidence considered individually. When evidence from different sources is ______, the auditor should determine what audit procedures are needed to resolve the inconsistency.

inconsistent

The auditor should use "relevant assertions" (those that have a meaningful bearing on whether the account is fairly stated) to assess the risk of material misstatement. The auditor should evaluate the nature of the assertion, the volume of transactions or data involved, and the complexity of the systems (including IT) by which the entity processes and controls the ________

information related to the assertion.

Perform Risk Assessment Procedures If management has not made an evaluation—Should discuss management's________of the going concern basis of accounting and inquire whether management may have substantial doubt about the entity's ability to continue as a going concern for a reasonable time.

intended use

Asserted Claims—With respect to asserted claims and active litigation "asserted" means that someone has already filed a claim or has at least announced the_______ , which is synonymous with the AICPA's term "pending or threatened litigation." According to the American Bar Association, the lawyer should inform the auditor directly about any omissions of asserted claims in the lawyer's letter responding to the letter of inquiry.

intention to make such a claim

Unasserted Claims—With respect to unasserted claims and potential litigation, "unasserted" means that the entity has exposure to litigation, but no one has yet announced an ___

intention to sue.The lawyer cannot

Subsequent Events—Dating the auditor's report when a subsequent event occurs after the completion of fieldwork but prior to the ________-If the financial statements are adjusted without any accompanying disclosure, the report should be dated whenever the auditor has obtained sufficient appropriate audit evidence (which may be the completion of fieldwork or later). In this case, there is no need to consider dual dating.

issuance of the auditor's report

The auditor should perform some substantive procedures for all relevant assertions related to each material class of transactions, account balance, and disclosure (regardless of the assessed risk of material misstatement), since there are inherent limitations to internal control and the assessment of risk is _____

judgmental

Narrowing a Range—The auditor's range should encompass all reasonable outcomes, not all possible outcomes. A high estimation uncertainty (significant risk) may be indicated if it is not possible to narrow the range to

less than or equal to performance materiality.

Subsequently Discovered Facts Known After the Report Release Date If Management Does Not Revise the Financial Statements—If the auditor believes that revision is necessary, the auditor should determine whether those financial statements have already been ______

made available to third parties.

The auditor should determine whether the overall audit strategy and audit plan need to be revised as a result of the identified misstatements. That would be necessary if the aggregate of accumulated misstatements (and other misstatements that may exist) approaches what is considered to be .

material

Subsequent Events Requiring Disclosure Only—Where disclosure of a_____ or transaction is necessary so that the financial statements will not be misleading, even though the subsequent events issue is unrelated to circumstances existing at the balance sheet date.

material event

The Auditor's Responsibilities Under the SAS Risk Assessment—The auditor should assess the risk of_____that could result from the entity's related-party relationships and transactions. The auditor should view any significant related-party transactions outside the entity's normal course of business as significant risks.

material misstatement

PCAOB on "Identifying and Assessing Risks of Material Misstatement" The auditor should perform risk assessment procedures sufficient to provide a reasonable basis for identifying and assessing the risks of

material misstatement and designing further audit procedures.

The auditor should design the substantive procedures to be responsive to the assessed risks of material misstatements. The purpose of substantive procedures is to detect_____

material misstatements at the relevant assertion level.

Indicators of Possible Management Bias—The auditor should consider whether the fair value accounting estimates

might indicate possible management bias.

PCAOB on Consideration of Materiality in Planning and Performing an Audit The auditor should plan andperform the audit to detect ____

misstatement that, individually or in the aggregate, would result in material misstatement of the financial statements.

PCAOB on Consideration of Materiality in Planning and Performing an AuditThe materiality level for the financial statements should be expressed as a specified amount to determine the

nature, timing, and extent of audit procedures.

Profit margin on sales=

net income/net sales

One or more lawyer's letters are expected to be included in the audit documentation. However, the SAS allows for the possibility that the entity may not have any relevant "litigation, claims, or assessments" having financial reporting significance. In that case, the auditor would include a specific statement of fact in the management representations letter stating that the entity had

no legal counsel to address current or potential litigation issues.

Nature of Estimation Uncertainty—High estimation uncertainty results in an increased risk of material misstatement when, for example: Fair value accounting estimates for derivative instruments are_______ Fair value accounting estimates are based on a _____

not publicly traded. highly specialized entity-developed model or when the assumptions (inputs) cannot be observed in the marketplace

he relevant AICPA guidance is provided by AU 505, External Confirmations. This pronouncement states that the auditor's objective is "to design and perform external confirmations to

obtain relevant and reliable audit evidence."

If management has examined a class of transactions or account balance at the auditor's request (e.g., as a result of an audit sample that indicates a misstatement) and has made a correction—The auditor should

perform additional procedures to determine whether any misstatements remain.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis Should consider all relevant information known to the auditor; and should consider the same -_______ that management used in its evaluation.

period

Note that this issue (whether the entity's lawyer has informed management of any omission of an unasserted claim that management should discuss with their auditors) is implicitly addressed in the management

representations letter.

PCAOB on audit panningThe engagement partner is responsible for the engagement and its performance. Accordingly, the engagement partner is responsible for __

planning the audit and may seek assistance from appropriate engagement team members in fulfilling this responsibility."

When the Estimation Uncertainty is High—The auditor may consider a combination of responses to the assessed risks, including reviewing outcomes, testing how management made its estimate, testing applicable controls, and developing a point estimate (or range) to evaluate management's

point estimate.

The auditor should evaluate whether the accounting estimates are reasonable (or are misstated) relative to the applicable financial reporting framework. The auditor is not responsible for

predicting future conditions, transactions, or events, however.

When Changes Are Made to Observable Information—The auditor should consider whether the assumptions used are consistent with what market participants would use for .

pricing purposes

Implications of Going Concern Issues for the Auditor's Report If disclosure is inadequate—Should either express a _______opinion, as appropriate.

qualified or adverse

Communication with Those Charged with Governance—Another SAS requires the auditor to communicate the auditor's views about the _____significant accounting practices, including accounting estimates. The auditor should determine that they are informed about the process used by management in developing sensitive accounting estimates, as well as the auditor's basis for conclusions about those matters.

qualitative aspects of the entity's

PCAOB on Audit Risk Auditor's objective —To conduct the audit of financial statements in a manner that

reduces audit risk to an appropriately low level.

The Auditor's Responsibilities Under the SAS Communication—The auditor should communicate with those charged with governance any significant matters involving the entity's

related parties.

The Auditor's Responsibilities Under the SAS Documentation—The auditor should include in the audit documentation the names of the identified related parties and the nature of the

related-party relationships and transactions.

"Sufficient" refers to the quantity of evidence, whereas "appropriate" refers to the quality of evidence in terms of its_____

relevance and reliability.

PCAOB on "Identifying and Assessing Risks of Material Misstatement"The auditor should begin by identifying and assessing the risks of material misstatement at the financial statement level and then work down to the significant accounts and disclosures and their

relevant assertions.

Identification of preparer and reviewer—the auditor should document who performed the audit work and who

reviewed the specific audit documentation.

The quantity of evidence required (related to "sufficient") is directly related to the____ (the greater the risk, the more evidence is needed) and inversely related to the quality of evidence (the higher the quality, the less evidence is needed).

risk of misstatement

The letter should be signed by those members of management with overall responsibility for financial and operating matters—ordinarily the chief executive officer (CEO) and the chief financial officer (CFO).Their unwillingness to sign the management representations letter would be a

scope limitation probably resulting in a disclaimer of opinion or withdrawal from the engagement.

Identifying and Assessing Risks of Material Misstatement—The auditor should evaluate the degree of estimation uncertainty involved and determine whether any of those fair value accounting estimates result in

significant risks.

Document audit procedures involving inspection of documents (including walkthroughs, tests of controls, and substantive tests of details)—Identify the

specific items tested (or the source and specific selection criteria); include abstracts or copies of significant contracts or agreements examined.

The PCAOB standards tended to provide a bit more specific guidance in certain areas (such as the engagement partner's responsibilities) that were originally addressed in somewhat more general terms in the AICPA standards; however, the AICPA's clarified auditing standards are now

very similar to PCAOB auditing standards in these areas.

Auditor's Evaluation of Management's Evaluation and Supporting Analysis When conditions or events are identified that raise —Should perform additional audit procedures, including consideration of any mitigating factors

substantial doubt

Implications of Going Concern Issues for the Auditor's Report If the auditor is unable to obtain sufficient appropriate audit evidence—Should either express a qualified opinion or disclaimer of opinion, as appropriate.When there is _________(but the use of the going concern basis of accounting is appropriate)— Should include an "emphasis-of-matter" paragraph (after the opinion paragraph) in the auditor's report.

substantial doubt about the entity's ability to continue as a going concern

Perform Risk Assessment Procedures If management has made an evaluation—Should discuss the evaluation with management and obtain an understanding of management's plans to mitigate the effects of conditions or events causing______

substantial doubt.

It is not necessary to rely on internal controls (i.e., test the operating effectiveness of controls) to extend the audit conclusions from the interim date to year-end. However, the auditor should consider whether only performing additional substantive procedures is ____.

sufficient

PCAOB on Supervision of the Audit EngagementAuditor's objective —To supervise the audit engagement so that the work is performed as directed and _____

supports the conclusions reached.

Reassess materiality—The auditor should reassess materiality to verify

that it is appropriate in view of the entity's actual financial results.

"Broker quotes generally provide more relevant and reliable evidence when they are ______ from unaffiliated market makers transacting in the same type of financial instrument."

timely, binding quotes, without any restrictions, limitations, or disclaimers,

PCAOB on "Identifying and Assessing Risks of Material Misstatement" What is the auditors objective?

to identify and appropriately assess the risks of material misstatement, thereby providing a basis for designing and implementing responses to the risks of material misstatement.

Outcome of an Accounting Estimate: The actual monetary amount that results from resolution of the

underlying matter addressed by the accounting estimate.

When Unobservable Inputs Are Significant to the Valuation—The auditor should evaluate the reasonableness of the

unobservable inputs.

"In general, fair values of financial instruments based on trades of identical financial instruments in an active market have a lower risk of material misstatement than fair values derived from observable trades of similar financial instruments or ______

unobservable inputs."

PCAOB on "The Auditor's Responses to the Risks of Material Misstatement"In responding to fraud risks, the auditor should address the risk of management override of controls by examining journal entries, reviewing accounting estimates for biases, and evaluating the business rationale for significant

unusual transactions.

PCAOB on Supervision of the Audit Engagement The extent of supervision required _____ with the engagement's circumstances, including the size and complexity of the company, the nature of the work assigned to engagement personnel, the capabilities of each engagement team member, and the risks of material misstatement. (The extent of supervision should be commensurate with those risks.)

varies

—The letter of inquiry normally includes the entity's listing of

various legal matters that the lawyer is handling (classified separately as Asserted Claims and Unasserted Claims) to facilitate the lawyer's response.

An auditor is required to obtain written representations from management to corroborate management's

verbal responses to important inquiries by the auditor.

When the entity's in-house counsel has responsibility for such litigation-related matters, the auditor should send a similar letter of inquiry to the in-house counsel and obtain a

written response.