FINAL EXAM STUDYGUIDE
Standard costs
costs assigned to products based on expected costs, which may differ from actual costs
Completeness
-all transactions and accounts that should be presented in the financial statements have been included
Reasonable assurance
A term that implies some risk that a material misstatement could be present in the financial statements without the auditor detecting it, even when the auditor has exercised due care.
Test of details for AR and related accounts: Foot A/R subsidiary ledger, agree total to GL
Accuracy
What are the benefits of prelisting cash? Who should prepare the list, and what other duties are incompatible with this duty?
Benefits: gives frame of reference for bank and book reconciliation Person who prepared list hands off the list to person who updates accounts
Test of details for AR and related accounts: Confirmation of A/R
Existence/Accuracy
Generally accepted auditing standards
Measures of the quality of the auditor's performance
Direction of testing example #2
Suppose an auditor is concerned that the client has failed to record some purchases of PPE. Think about how this could be tested. Which assertion is the auditor concerned with? -completeness
Test of controls
a. tolerable deviation rate b. expected population deviation rate c. sample deviation rate d. computed upper deviation rate
Ratio of misstatement in stratum
amount of misstatement/book value of sample *book value of stratum
Typical purchase transaction controls: receiving reports initiate recording of accounts payable
completeness
detection risk of model
determined based on the other risk components (this is the amount of detection risk the auditor is able to take and still say within the set level of AR)
Assurance services
independent professional services that improve the quality of information, or its context, for decision makers
ABC Corp.'s management is under intense pressue to meet annual revenue growth targets of 20%
inherent risk
Discussing the adequacy of the allowance for doubtful accounts with the credit manager.
inquiry
VA-Cutoff Assertion: a shipment made on October 25 is recorded as a November sale
issue in sales journal -> use shipping documents with date on them. This date is when finalized sale, date and field in journal. FOB destination is ok FOB Shipping Point is the issue at hand
Which of the following concepts are pervasive in the application of auditing standards? a. internal control b. expected misstatement c. control risk d. materiality and audit risk
materiality and audit risk
Loss contingency: possible
note disclosure onl
What concerns about inventory transactions and balances pairs with the VA-valuation assertion?
obsolescence/condition; lower cost or market
Last receiving report number in 2018 was 49,745 12/31 49,744
okay because in December belong to company
VA-Accuracy assertion: the company ordered 25 widgets, but only 20 were actually received
purchase order agreed to receiving report
Remote
the chance of the future event occurring is slight
Obtaining an understanding of internal control
-prior year work papers/ permanent files -client inquiry -observation -inspection of documents ** perform a walkthrough
Types of transactions and Financial Statement Accounts Affected in the Purchasing Process
-purchase transaction -cash disbursement transaction -purchase return transaction
A plaintiff is suing an auditor under the provisions of Section 11 of the 1933 Act. What elements must be proven by the plaintiff?
1. plaintiff suffered a loss by investing in the security 2. the audited F/S contained a material misstatement or omission (do not have to prove fraud or reliance or casual connection)
Reporting (7th principle)
7. in a written report, express an opinion or state than an opinion can not be expressed; opinion states whether the F/S are presented fairly in all material respects in accordance with the applicable financial reporting framework [GAAP]
Privity
A party's contractual or fiduciary relationship with the accountant
Significant risk
A risk of material misstatement that is important enough to require special audit consideration.
An auditor's primary consideration regarding an entity's internal controls is whether they a. prevent management override b. relate to the control environment c. reflect management's philosophy and operating style d. affect the financial statements assertions
Affect the financial statements assertions
Public accounting firm
An organization created to provide professional accounting-related services, including auditing. Usually formed as a proprietorship or as a form of partnership.
Highest level of assurance given
Audit --> audit of GAAP F/s Examination --> examination of prospective F/S
Preliminary activities
Audit team requirements -technical skills -continuity verify and document compliance with independence rules
Example for a perpetual inventory system: Ending inventory per books: 750 Ending inventory per physical count: 700
DR COGS 50 CR Inventory 50
Necessary adjusting journal entries at 8/31 for inventory related accounts
DR Inventory CR COGS perpetual system -> every time purchase was recorded wrong, COGS was recorded
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. A company's internal control over financial reporting includes those policies and procedures that pertain to the maintenance of records...
Definition and limitation of ICFR
A necessary substantive procedure was omitted from the audit program
Detection risk
Last receiving report number in 2018 was 49,745 1/02 none
Explanation indicated the expense was the December 2018 telephone bill, so should be in December DR Telephone Expense 32,450 CR Accounts Payable 32,450
True or false: Type II subsequent events are conditions that require an adjustment to account balances shown on the financial statements
False
True or false: dual dating is used to identify unrecorded contingent liabilities
False
What concerns about inventory transactions and balances pairs with the presentation and disclosure assertion?
GAAP requirements adequately disclosed (cost flow assumption, LCM, purchases, commitments, RPTs, pledged inventory)
The auditor is concerned that payments are being made for large purchases on account that were not pre-approved Design a test of controls that tests the authorization assertion for cash disbursements
Have authorization controls in place that flag purchases above entity's dollar limit approved purchase order before purchase was made or a dollar amount (1) first look at if they have a cut-off (2) look for purchase order for large number and make sure to see approval
Holding out
In general, any action initiated by a member that informs others of his or her status as a CPA or AICPA-accredited specialist constitutes holding out as a CPA. This would include, for example, use of the CPA designation on business cards or letterhead, or listing as a CPA in local telephone directories.
For tax reasons, Management has a strong interest in employing inappropriate means to minimize reported earninsg
Incentives
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. Nixon has an inadequate system for recording cash disbursements which could have presented the company from recording cash disbursements completely and properly
Material Weakness disclosure
Report Title
PCAOB report guidance: Report of Independent Registered Public Accounting Firm AICPA report guidance: Independent Auditor's Report
The company has clear legal title to all items included in the inventory balance
Rights and obligations
Dual-purpose tests
Tests of transactions that both evaluate the effectiveness of controls and detect monetary errors.
Projected misstatements
These are the auditor's best estimate of misstatements in populations, involving the projection of misstatements identified in an audit sample to the entire population from which the sample was drawn.
Illegal acts
Violations of laws or government regulations
The current file of the auditor's working papers should generally include a. a flowchart of the accounting system b. organization charts c. a copy of the financial statements d. copies of bond and note indentures
a copy of the financial statements
Contingent liability
an existing condition or set of circumstances involving uncertainty about a possible loss that will ultimately be resolved when some future event occurs or fails to occur
control risk of model
assessed by the auditor
inherent risk of model
assessed by the auditor
Purchasing process typical transaction: Prepaids-set up
balance sheet: A/P or cash; prepaid asset
Purchasing process typical transaction: Return inventory
balance sheet: A/P; Inventory (or purchases returns and allowances) income statement: none
Revenue Process: Uncollectibility Allowance (Write-off)
balance sheet: allowance for doubtful accounts, accounts receivable income statement: N/A
Revenue process: Cash sale transaction
balance sheet: cash income statement: sales
Revenue process: Customer return
balance sheet: cash or accounts receivable income statement: sales returns and allowances
Disbursements have occurred without proper approval
control risk
Application controls
controls that apply to the processing of specific computer applications and are part of the computer programs used in the accounting system
General controls
controls that relate to the overall information-processing environment and have a pervasive effect on the entity's computer operations
Revenue transaction controls: shippers forwarded to billing daily; daily billing of shipments
cut-off
Revenue transaction controls: shippers reflect date of shipment
cut-off
Because of some unusual equity transactions this year, it has been decided that the equity accounts need to be audited to a very tight precision
decrease tolerable misstatement
Because some changes were made to the inventory system in the current year, you expect more errors in that account in the current year than in past years.
decrease tolerable misstatement for inventory
Auditing Fair Value of Investments: Level 1
description: active market exists for the security valuation method: mark to market
Analytical procedures
evaluations of financial information made by an analysis of plausible relationships among both financial and non-financial data
If accounts receivable turnover (credit sales/receivables) was 7.1 times last year compared to only 5.6 times in the current year, it is possible that there were a. unrecorded credit sales in the current year b. unrecorded cash receipts last year c. more thorough credit investigations made by the company late last year d. fictitious sales in the current year
fictitious sales in the current year
Procedures to obtain an understanding of the company/environment/internal control
inquiry -management, internal audit, other employees, audit committee analytical procedures -required at the planning stage -high level ratio and trend analysis observation inspection -internal control documentation, board minutes, internal audit reports, interim financial statements
Cash receipts controls: lock-box system
occurrence, completeness
FOB destination
ownership of the goods remains with the seller until the goods reach the buyer
Performing test counts of the warehouse personnel's count of the raw material
reperformance
Major functions within the purchasing process
requisitioning purchasing receiving invoice processing disbursements accounts payable general ledger
Which audit procedure matches with this assertion: ensure that all revenue-related disclosures are made in the financial statements
review of drafts of financial statements
Criminal law
statutory law that defines the duties citizens owe to society and prescribes penalties for violations
Specific audit procedures conducted near completion of audit: Obtain a legal letter
that describes and evaluates any litigation, claims, or assessments
The "expectation gap"
the auditor's role -provides reasonable assurance that financial statements are free of material misstatement and in conformity with GAAP -exercise due professional care when performing the audit society's expectation of the auditor's role -produce correct financial statements -detect all errors, fraud, illegal acts
Reasonably possible
the chances of the future event occurring is more than remote but less than probable
Presentation and disclosure
the components of the financial statements are properly classified, described, and disclosed
Materiality definition
the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. materiality is a matter of professional judgment
Substantial doubt
there is doubt about the continuing as a going concern and that is a bad thing
Type of liability: breach of contract
typical plaintiffs: client
periodic inventory system
use "purchases" account during the year; physical count at the of period is source of information for determining COGS; closing journal entry to update inventory, close purchases, and record COGS
CISA - Certified Information Systems Auditor
-Information systems audit and control association (ISACA)
Roles and responsibilities
-management is responsible for 1. maintaining internal controls 2. preparing the financial statements 3. management asserts that the financial statements are "right" (i.e., fairly stated in conformity with GAAP) -auditor is responsible for 1. testing this assertion (and multiple underlying assertions) and determining whether it is true 2. rendering an opinion on the financial statements -third parties (investors, creditors, etc.) use the financial statements as a basis for their decisions
Steps in attribute sampling: Planning
-objective of the test -population characteristics 1. sampling population 2. sampling unit 3. deviation -determine sample size required based on 1. desired confidence level 2. expected deviation rate 3. tolerable deviation rate
Other types of audit reports
-unqualified with additional paragraphs (and maybe some modified wording) -qualified -disclaimer -adverse
Sending a written request to the entity's customers requesting that they report the amount owed to the entity.
Confirmation
Disbursements have occurred without proper approval
Control risk
Application controls
Controls that apply to the processing of specific computer applications and are part of the computer programs used in the accounting system.
Special purpose financial statements
Financial statements prepared under cash basis, tax basis, regulatory basis, or contractual basis (formerly referred to as "other comprehensive basis of accounting").
Inspection of tangible assets
Physical examination of the tangible assets.
Revenue: design a test of transactions that tests the EXISTENCE/OCCURRENCE assertion for sales transactions
Population: sales journal For a sample of entries in sales journal: Verify presence of approved customer order and supporting shipping documents.
Test of details for AR and related accounts: Perform sales cut-off testing
VA-cut-off
Ethics
a system or code of conduct based on moral duties and obligations that indicates how an individual should behave
Compare gross profit percentage for the current year to prior years for reasonableness
evidence type: analytical procedures assertion: valuation/allocation-accuracy
Send a written request to the client's customers requesting that they verify that the account balance owed at 12/31 agrees to their records
evidence type: confirmation assertion: existence
What is the definition of "independent"
not addressed
FOB Shipping point
ownership of the goods passes to the buyer when the public carrier accepts the goods from the seller
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy Extensive testing of controls is performed to verify their effectiveness
reliance
Which audit procedure goes well with this specific assertion? Verify that all accounts payable are recorded in the correct period (cutoff)
select a sample of receiving documents for a few days before and after year-end
Expected misstatement
the amount of misstatement that the auditor believes exists in the population
Which of the following statements about internal control is correct? a. a properly maintained internal control system reasonably ensure that collusion among employees cannot occur b. the establishment and maintenance of internal control is an important responsibility of the internal auditor c. an exceptionally strong internal control system is enough for the auditor to eliminate substantive procedures on a significant account balance d. the cost-benefit relationship is a primary criterion that should be considered in designing an internal control system
the cost-benefit relationship is a primary criterion that should be considered in designing an internal control system
Scope limitation
A lack of evidence that may preclude the auditor from issuing a clean opinion, usually resulting from an inability to conduct an audit procedure considered necessary.
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
Financial statements are fairly stated. Auditor issues an unqualified opinion on the financial statements. Client business falls the following year.
Opinion was appropriate. Auditor not liable
Purchase: design a test of details that tests the PRESENTATION AND DISCLOSURE assertion for accounts payable
Review note disclosures and complete GAAP disclosure checklist to ensure that all necessary disclosures related to accounts payable have been made
Which audit procedure matches with this assertion: confirm that recorded accounts receivable are valid (existence)
confirmation of accounts receivable
Randomly select items from the inventory listing and determine that they are on hand in the warehouse
evidence type: inspection of tangible assets assertion: existence
CFE- Certified Fraud Examiner
-association of certified fraud examiners (ACFE)
COGS formula
beginning inventory +purchases= goods available for sales - ending inventory= COGS
Civil law
All law that does not relate to criminal matters
Control activities
The policies and procedures that help ensure that management's directives are carried out.
Types of reports on ICFR -adverse opinion
if material weakness exists on the as of date
Desired confidence level
relationship to sample size: direct
audit risk of model
"acceptable" audit risk is set by auditor at planning, after considering engagement risk
Revenue: design a test of details of balances that tests the RIGHTS AND OBLIGATIONS assertion for accounts receivable
(1) review bank confirmation for evidence that accounts receivable was pledged as collateral (2) review loan agreements for evidence that accounts receivable was pledged as collateral
Additional Required Communications in an Audit of ICFR
Significant Deficiencies and Material Weaknesses -the auditor must communicate in writing to management and the audit committee all significant deficiencies and material weaknesses identified during the audit. This communication should be made prior to the issuance of the auditor's report on ICFR. Control deficiencies -in addition, the auditor should communicate to management, in writing, all control deficiencies identified during the audit and inform the audit committee when such a communication has been made
Significant deficiencies are matters that come to an auditor's attention that should be communicated to an entity's audit committee because they represent a. disclosures of information that significantly contradict the auditor's going concern assumption b. material fraud or illegal acts perpetuated by high-level management c. significant deficiencies in the design or operation of the internal control d. manipulation or falsification of accounting records or documents from which financial statements are prepared
Significant deficiencies in the design or operation of the internal control
Inventory issues meriting special consideration
- cutoff (related to revenue fraud risk) -fraud (notorious cases and the lessons we have learned) -obsolescence (may or may not be an issue)
What is a "misstatement"
-A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be presented fairly in accordance with the applicable financial reporting framework (GAAP). -the omission of a financial statement element, account, or item -a financial statement disclosure that is omitted or not presented in accordance with GAAP
Disciplinary Actions
-AICPA (Professional Ethics Executive Committee) 1. remedial or corrective action 2. suspension 3. termination 4. published in CPA newsletter -State Board 1. suspend or revoke license to practice SEC and PCAOB 1. fines 2. suspension or permanent bar
Quality Control
-CPA firms are required to implement policies to monitor the firm's practices and ensure that professional standards are being followed. 1. PCAOB administers the quality inspection program for auditors of public companies 2. AICPA administers the system for auditors of non-public companies Elements of quality control 1. leadership (tone at the top) 2. ethics 3. client acceptance and continuance 4. human resources 5. engagement performance 6. monitoring
Gray, CPA has a small public accounting practice, but does not perform any tax services. John Jones, one of Gray's clients, needs to have some tax services performed. Gray has referred John Jones to Brown, CPA for these tax services. Brown has agreed to pay Gray a referral fee equal to 10% of the fee he collects on any referred services. John Jones has been informed of this arrangement.
-Commission and Referral Fee -NOT violation as long as client is informed, this case he is
Auditing Accounts Payable and Accrued Expenses
-Existence: accounts payable and accrued expenses are liabilities -rights and obligations: accounts payable and accrued expenses are obligations of the entity -completeness: all accounts payable and accrued expenses have been recorded -valuation and allocation: accounts payable and accrued expenses are included in the financial statements at appropriate amounts, and any resulting valuation or allocation adjustments are appropriately recorded
Compare combined misstatement to materiality
-If combined misstatement < planning materiality = OK -If combined misstatement > planning materiality= NOT OK 1. auditor may decide to expand testing in problem accounts and get a better estimate of the misstatement amount 2. auditor should discuss with client the need to record adjustments for material misstatements; otherwise, can not issue an unqualified opinion
ICFR Defined
-PCAOB standards defines ICFR as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with GAAP. Controls include procedures that 1. Pertain to the maintenance of records that fairly reflect transactions 2. Provide reasonable assurance that transactions are recorded as necessary in accordance with GAAP 3. Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition; use or disposition of the company's assets that could have a material effect on the financial statements
Performing an Audit of ICFR
-Planning 1. risk assessments, fraud risk 2. scaling (size and complexity) 3. using the work of others -Top-down, risk-based approach 1. entity level controls 2. significant accounts and their relevant assertions 3. likely sources of misstatement 4. key controls to be tested -test design and operating effectiveness -evaluate any identified deficiencies 1. consider potential for material misstatements 2. consider actual material misstatements that occurred -form an opinion on effectiveness of ICFR -documentation
Existence or occurrence (includes authorization)
-assets and liabilities exist as of a given date -recorded transactions occurred during the period
Statistical sampling attributes
-uses laws of probability to compute sample sizes and evaluate -provides most efficient sample sizes -able to quantify "allowance for sampling risk" in test of controls --> attribute sampling in tests of balances --> monetary unit sampling (MUS)
Types of services provided by accountants (assurance)
1. Audits -financial statement -ICFR -operational -compliance -forensic 2. Non-audit -attest (e.g., F/S review) -other assurance services
Setting the tolerable deviation rate
1. Highly dependent on: how important the auditor things the control is in preventing a misstatement -assessed importance of a control is highly important: 3-5% -assessed importance of a control is moderately important: 6-10% 2. how much reliance the auditor plans to place on the control. -the higher the planned level of reliance, the lower the deviation rate the auditor will be able to accept
Generally accepted auditing standards
Standards against which the quality of the auditor's performance is measured.
Standards (AS) of the PCAOB
Standards regarding the conduct of financial statement audits for public companies. Currently consist of a mix of standards and statements established by the ASB, as these statements and standards were adopted by the PCAOB in 2003 on an interim basis, together with Auditing Standards (AS) issued by the PCAOB since 2003.
International Standards of Auditing (ISA)
Statements issued by IFAC's International Auditing and Assurance Standards Board.
Statements on Auditing Standards (SAS)
Statements issued by the AICPA's Auditing Standards Board.
Three important factors in determining sample size
1. confidence (desired level of assurance in the results) 2. expected deviation rate OR expected misstatement (anticipated amount of deviation or misstatement based on past experience and current conditions) 3. tolerable deviation rate OR tolerable misstatement (the maximum amount of deviation or misstatement that could occur and the auditor would still find it to be "good enough")
Types of auditors
1. external -big 4, mid-tier, regional, and local CPA firms -audit team typically consists of the following levels: partner, manager, senior, staff 2. internal 3. government -e.g. GAO, IRS 4. forensic
Sampling in test of controls: the big picture
1. identify a control that you preliminary plan to rely on to some degree. Since there will generally be some occurrences where the control does not work effectively, identify the amount of deviation you expect to find. 2. Identify the maximum amount of deviation that you could tolerate and still feel that the control is functioning well enough to support your planned level of reliance/control risk assessment 3. Select sample. Identify deviations in the sample. Use this info to make a judgment about the population 4. Evaluate results. Determine whether the control can be relied on as planned (i.e. whether it supports planned control risk) -YES: Continue audit with planned level of reliance on control and planned level of substantive testing of balances -NO: Revise audit plan- increase control risk assessment; reduce reliance on control; increase level of substantive testing of affected balances
Purpose and premise of an audit (1st and 2nd principles)
1. provide an auditor's opinion (whether F/S present fairly in accordance with reporting framework) to enhance user confidence in financial statements 2. Management has responsibility for a. preparing F/S in accordance with [GAAP] and maintaining IC for preparing F/S free of material misstatement (whether from fraud or error) b. providing auditor with information and access to obtain audit evidence
James Ingram, CPA uses business cards and promotional materials that indicate that he is an "IT Specialist." James has no background on training in Information Technology.
1.800 For Organization and Name Rule Not allowed to create a name that is misleading VIOLATION
In which of the following situations would a CPA's independence be considered impaired according to the Code of Professional Conduct? 1. The CPA has a car loan from a bank that is an audit entity. The loan was made under the same terms available to all customers. 2. The CPA has a direct financial interest in an audit entity, but the investment is maintained in a blind trust. 3. The CPA owns a commercial building and leases it to an audit entity. The rental income is material to the CPA. a. 1 and 2 b. 2 and 3 c. 1 and 3 d. 1, 2, and 3
2 and 3
Material Weakness communication of internal control-related matters
A deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis *must be communicated in writing to management and to those charged with governance
Engagement letter
A letter that formalizes the contract between the auditor and the entity and outlines the responsibilities of both parties.
Close relative
A parent, sibling, or non dependent child.
Internal control over financial reporting
A process designed by, or under the supervision of, the entity's principal executive and principal financial officers, or persons performing similar functions, and effected by the entity's board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
Monitoring of controls
A process that assesses the quality of internal control performance over time.
Positive confirmation request
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.
Exception
A response that indicates a difference between information requested to be confirmed, or contained in the entity's records, and information provided by the confirming party.
Immediate family
A spouse, spousal equivalent, or dependent (whether or not related).
Audit committee
A subcommittee of the board of directors that is responsible for the financial reporting and disclosure process
Internal Control (defintion from COSO framework)
A system designed to provide reasonable assurance that an entity's objectives are being achieved in a. reliable reporting b. effective and efficient operations; safeguarding of asset c. compliance with laws and regulations Management: responsible for maintaining controls Auditor: primarily concerned with reliability of financial reporting and understanding of client's internal controls is a GAAS principles requirement
Auditing
A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
Walkthrough
A transaction being traced by an auditor from origination through the entity's information system until it is reflected in the entity's financial reports. It encompasses the entire process of initiating, authorizing, recording, processing, and reporting individual transactions and controls for each of the significant processes identified.
Illegal act
A violation of laws or government regulations.
Significant Deficiency
AS 2201 definition -a deficiency (or combination) in ICFR that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting
For the following, determine which type of opinion on ICFR as of 12/31/X1 should be given by the external auditor. During the audit of ICFR for Al and Larry Industries, the auditor noted several internal control deficiencies. The auditor determined that there is a reasonable possibility that any one of them could result in a misstatement that is significant, and believes there is a moderate likelihood that the deficiencies, individually or taken together, could result in a material misstatement.
Adverse opinion because the significant deficiencies identified produce moderately low risk of material misstatement within reasonably possible, this combination is considered a material weakness
Significant account or disclosure
An account or disclosure is significant if there is a reasonable possibility that the account or disclosure could contain a misstatement that, individually or when aggregated with others, has a material effect on the financial statements, considering the risks of both overstatement and understatement.
Integrated audit
An audit of both financial statements and internal control over financial reporting, provided by the external auditor. Required for public companies.
Auditor specialist
An individual or organization possessing expertise in a field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. An auditor's specialist may be either an auditor's internal specialist (who is a partner or staff, including temporary staff, of the auditor's firm or a network firm) or an auditor's external specialist.
Grant Thornton completes an engagement and issues a report stating that Abbot Corp., a large public company, did not maintain, in all material respects, effective internal controls over financial reporting.
Audit of ICFR
PCAOB filing requirements regarding audit participants
Auditors of Public Companies are required to file form AP with the PCAOB 1. name of engagement partner 2. information about other accounting firms participating in the audit 3. this information may also be provided in the auditor's report, if the auditor chooses to do so AuditorSearch database on the PCAOB website allows users to search and access this information
The general accreditation granted by the Institute of Internal Auditors is known as the A. CFE B. CGAP C. CFSA D. CIA
CIA
COSO Framework: Components of Internal Control
COSO= Committee of Sponsoring Organizations of the Treadway Commission 1. control environment 2. entity's risk assessment 3. information and communication 4. control activities 5. monitoring
All cash disbursements transactions have been recorded
Completeness
Which control activity, assertion, and test are appropriate for this control? Change-access to the payroll master files (salaries, hourly wages, etc.) is password protected
Control activity: Information processing control - General Assertion: occurrence/authorization Test: observe staff type a password OR try to get into file and see if it is password protected
Beginning inventory: 500 Net purchases: 800 Goods available for sale: 1300 Ending inventory physical count: 700 (understated by 60) COGS: 600 (overstated by 60) assume that a purchase of $60 near year end was correctly recorded as a 20X1 purchase, but because the units were not in the warehouse at the time of the physical count, these items were improperly exclude from the physical count. What adjusting entry is necessary to correct this error?
DR Inventory 60 CR COGS 60
interbank transfer schedule #1 amount, recorded in client books, paid by bank (disbursements); recorded in clients books, received by bank (receipts) $8,400 12/31, 1/2; 12/31,1/2
Disbursement account: crosses year-end timing issues (outstanding check) Receipts account: crosses year-end timing issue (deposits in transfer)
The auditor would like to estimate the amount of the company's Accounts Receivable that are likely to be uncollectible. Design a substantive analytical procedure that tests the VA-REALIZABLE VALUE assertion for Accounts Receivable
Do an aging analysis this year and compare to last year percentage in each aging bracket
The AS contains guidance for performing substantive testing to respond to the risk of material misstatement in estimates, and it identifies three distinct approaches for auditing the client's estimates. Which section number of the guidance sets forth these three approaches?
Evaluating Reasonableness (0.10)
Inspection of records and documents
Examination of internal or external records or documents that are in paper form, electronic form, or other media.
Assertions
Expressed or implied representations by management regarding the recognition, measurement, presentation, and disclosure of information in the financial statements and related disclosures.
True or false: the external auditor is responsible for performing the physical count of all material inventory
False
The auditor's decision in non-statistical sampling: Test of Controls
If sample deviation rate exceeds tolerable, do NOT rely If sample deviation rate is lower than expected, RELY If sample deviation rate is between tolerable and expected- grey area. AICPA Audit Guide encourages a conservative interpretation and suggests NOT relying
Steve Rackwill, CPA, has been asked by his audit client, Petry Plumbing (a private company), to assist with the process of hiring new employees. Rackwill will help set up interview for potential new personnel. Petry Plumbing will make all hiring decisions and will supervise employees once they are hired 1.200
Independence (management participation), making management decisions -not a violation because Petry is making all management decisions
High levels of overtime by clerical workers in the A/P department have resulted in numerous recording errors because of carelessness and fatigue
Inherent risk
Examining large sales invoices for a period of two days before and after year-end to determine if sales are recorded in the proper period.
Inspection of records or documents
Audits of Public Companies
Issued by: the PCAOB (since 2003) Guiding Framework: none Body of Standards: "The Standards of the Public Company Accounting Oversight Board (U.S.)" Individual standards: auditing standards (AS) Numbering System: chronological: none topical: by AS numbers
Substantive test of transactions
Tests to detect errors or fraud in individual transactions.
To be successful in a civil action under Section 11 of the Securities Act of 1933 concerning liability for a misleading registration statement, the plaintiff must prove defendant's intent to deceive, plaintiff's reliance on the registration statement a. yes, yes b. yes, no c. no, yes d. no, no
NO, NO
Jason Brand is a Partner in the Dallas office of Old and Older, CPAs. Jason's largest audit client is Abbot Industries, and he is the lead partner on that engagement. Jason is also the partner on the review engagement RevCo's financial statements. Determine whether each of the following scenarios constitutes an independence violation for Jason or for Older and Older. Jason's wife, Ann, recently took a job as CFO of Arbor Industries, an audit client of Old and Older's Houston office. Jason does not participate in the Arbor audit.
No -Jason is not a covered member for that audit client *firm may interpret differently*
Last receiving report number in 2018 was 49,745 12/31 none
No receiving report because it is a service not a good. Payment is for 3 months, but 1 month happened in 2018 DR Prepaid Expenses 30,000 CR Consulting Expense 30,000
Deloitte performs a financial statement compilation for a small non-profit entity.
Non-assurance
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (US), the financial statements of Zinger Corp....
Opinion on Internal Control Over Financial
Tolerable misstatement (performance materiality)
The amount of the overall materiality that is used to establish a scope for the audit procedures for the individual account balance or disclosures.
Joint and several liability
The auditor can be responsible for the entire loss even if other parties contributed to the loss
Substantive Strategy breakdown
The auditor obtains an understanding of internal control -there are no controls that pertain to the assertion or controls are preliminary assessed as ineffective or testing the effectiveness of controls is inefficient. The auditor may choose to set control risk at the maximum and follow a substantive strategy for some or all assertions **do NOT rely on controls**
Reliance strategy
The auditor's decision to rely on the entity's controls, test those controls, and reduce the direct tests of the financial statement accounts.
Reasonable assurance
The concept that an audit done in accordance with auditing standards may fail to detect a material misstatement in a client's financial statements. In an auditing context this term has been defined to mean a high but not absolute level of assurance.
Expected population deviation rate
The deviation rate that the auditor expects to exist in the population.
Reliability of evidence
The diagnosticity of evidence—that is, whether the type of evidence can be relied on to signal the true state of the assertion.
Reporting
The end product of the auditor's work, indicating the auditing standards followed and expressing an opinion as to whether an entity's financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP).
Representative sample
The evaluation of the sample will result in conclusions that are similar to those that would be drawn if the same procedures were applied to the entire population.
Risk assessment
The identification, analysis, and management of risks relevant to the preparation of financial statements that are fairly presented in conformity with GAAP.
Sampling unit
The individual items constituting a population being sampled
"Best opinion type"
PCAOB report guidance: unqualified opinion AICPA report guidance: unmodified opinion
Purchase: design a test of details of balances that tests the COMPLETENESS assertion for accounts payable
Perform a search for unrecorded liabilities by reviewing cash disbursements after the balance sheet date. Review supporting documentation to determine the period of the purchase. For item purchased before 12/31, verify that item is included in December purchases journal and 12/31 accounts payable listing
What types of misstatements is an auditor expected to detect?
Performance, principle 4 -only material misstatements
What level of assurance about whether there are misstatements should an auditor obtain?
Performance, principle 4 -reasonable assurance
How does an auditor identify and assess risks of material misstatement?
Performance, principle 5 -plan and supervise, assess materiality, assess RMM, obtain sufficient evidence
Are there generally limitations on the auditor's ability to identify misstatements?
Performance, principle 6 -cannot obtain absolute assurance due to inherent limitation
3. Securities Exchange Act of 1934 [section 10(b) fraud provisions have greatest impact on auditors]
Plaintiff must prove 1. a material, factual misrepresentation or omission 2. reliance on the financial statements 3. damages suffered as a result of reliance on the financial statements 4. scienter (intent to deceive/knowledge of false representation)
3. Securities Act of 1933 (section 11) pertains to info in registration statements
Plaintiff must prove only the following 1. plaintiff suffered losses by investing in the registered security 2. the audited financial statements in the registration statement contained a material omission or misstatement *reverse burden of proof* auditor must prove that he was not negligent "due diligence" a reasonable investigation of the facts was made
The company's financial performance is threatened by a high degree of competition and market saturation, and the company is close to violating debt covenants
Pressures
Business processes
Processes implemented by management to achieve entity objectives. Business processes are typically organized into the following categories: revenue, purchasing, human resource management, inventory management, and financing processes.
Financial forecasts
Prospective financial statements that present an entity's expected financial position, results of operations, and cash flows.
A violation of the profession's ethical standards is least likely to occur when a CPA a. purchases another CPA's accounting practice and bases the price on a percentage of the fees accruing from entities over a three-year period b. receives a percentage of the amounts invested by the CPA's audit entities in a tax shelter with the entities' knowledge and approval c. has a public accounting practice and is president and sole stockholder of a corporation that engages in data processing services for the public. the CPA often refers his attest entities to the data processing company. d. forms an association- not a legally binding partnership- with two other sole practitioners and calls the association Adams, Betts, and Associates, CPA's
Purchases another CPA's accounting practice and bases the price on a percentage of fees accruing from entities over a three-year period
Scope of the audit
Refers to the nature, timing, and extent of audit procedures, where nature refers to the type of evidence; timing refers to when the evidence will be gathered; and extent refers to how much of the type of evidence will be evaluated.
Moderate level of assurance given (limited)
Review --> evidence is gathered, but to a lesser extent than for an audit or examination
Inquiry
Seeking information of knowledgeable persons, both financial and nonfinancial, within the entity or outside the entity.
Practice of public accounting
The performance for an entity, by a member or a member's firm, while holding out as CPA(s), of the professional services of accounting, tax, personal financial planning, litigation support services, and those professional services for which standards are promulgated by bodies designated by Council.
Audit sampling
The selection and evaluation of less than 100 percent of the population of audit relevance such that the auditor expects the items selected to be representative of the population and, thus, likely to provide a reasonable basis for conclusions about the population.
Control environment
The tone of an organization, which reflects the overall attitude, awareness, and actions of the board of directors, management, and owners influencing the control consciousness of its people.
Electronic data interchange
The transmission of business transactions over telecommunications networks.
Allowance for sampling risk
The uncertainty that results from sampling; the difference between the expected mean of the population and the tolerable deviation or misstatement.
Classical variables sampling
The use of normal distribution theory to estimate the dollar amount of misstatement for a class of transactions or an account balance.
Audit data analytics
Using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data and in the context of the audit
Revenue transaction controls: sales invoices reconciled to daily sales report; daily sales journal totals reconciled to general ledger posting
VA-Accuracy (posting and tie-in)
Typical cash disbursement controls: daily reconciliation of checks issued to cash disbursements total and posting to accounts payable
VA-Accuracy, cut-off
Typical purchase transaction controls: purchasing department works from approved vendor lists and price lists; system does not allow purchase order to be initiated for vendors who are not in the vendor list
VA-accuracy/authorization
Portions of debt that are due within the upcoming year are shown as current liabilities
Valuation/Allocation -Classification
Young and Younger, CPAs have been engaged to perform the audit of ABC Corp. The audit will be performed by the firm's Chicago office. For each of the following scenarios, determine whether the person in question qualifies as a "covered member." Steve Hops is the managing partner of the Chicago office of Young and Younger, but does not participate in the ABC engagement.
Yes -because partner is in primary office
Significant deficiency
a control deficiency, or a combination of control deficiencies, that is less severe than a material weakness, but important enough to merit attention by those responsible for oversight of the company's financial reporting
Management letter
a letter from the auditor to management making recommendations to the entity based on observations during the audit; the letter may include topics relating to organizational structure and efficiency issues
Closest reasonable estimate
a range of acceptable amounts or a precisely determined point estimate for an estimate (e.g. uncollectible receivables), if that is a better estimate than any other amount
Revenue process
a recurring set of business activities and related information processing operations associated with providing goods and services to customers and collecting cash in payment for those sales
Procedures for testing investments
a substantive strategy for auditing investments generally makes sense (except in the case of broker/dealers)
One of a CPA firm's basic objectives is to provide professional services that conform with professional standards. Reasonable assurance of achieving this basic objective is provided through a. a system of quality control b. a system of peer review c. continuing professional education d. compliance with generally accepted reporting standards
a system of quality control
Proof of cash
a technique used to reconcile the cash receipts and disbursements record on the entity's books with the cash deposited into and disbursed from the entity's bank account for a specific time period
Tort
a wrongful act other than breach of contract for which civil action may be taken
Which of the following control activities is not usually performed in the accounts payable department? a. matching the vendor's invoice with the related receiving report b. approving vouchers for payment by having an authorized employee sign the vouchers c. indicating the asset and expense accounts to be debited d. accounting for unused prenumbered purchase orders and receiving reports
accounting for unused prenumbered purchase orders and receiving reports
Scienter
acting with intent to deceive, defraud, or with knowledge of a false representation
Varies by engagement for level of assurance given
agreed-upon procedures --> issue a summary of findings based on the specifics of the engagement
Ordinary negligence
an absence of reasonable or due care in the conduct of an engagement
Subsequent event
an event or transaction that occurs after the balance sheet date but prior to the issuance of the financial statement and the auditor's reports that may materially affect the financial statements
Contingent liability
an existing condition, or set of circumstances involving uncertainty as to possible loss to an entity that will ultimately be resolved when some future eent occurs or fails to occur
Fraud
an intentional act by one or more among management, those charged with governance, employees, or third parties, involving the use of deception that results in a misstatement in the financial statements
Understatement of a company's ending inventory will cause a. an overstatement of purchases b. an overstatement of cost of goods sold c. an understatement of goods available for sale d. an understatement of inventory turnover
an overstatement of cost of goods sold
In auditing a public company, Natalie, an auditor for N. M. Neal & Associates, identifies four deficiencies in ICFR. Three of the deficiencies are unlikely to result in financial misstatements that are material. One of the deficiencies is reasonably likely to result in misstatements that are not material but significant. What type of audit report should Natalie issue? a. an unqualified report b. an adverse report c. a disclaimer of opinion d. an exculpatory opinion
an unqualified opinion
Comparing the current-year gross profit percentage with the gross profit percentage for the last four years.
analytical procedures
Critical (or key) audit matter
any matter arising from the audit of the financial statements communicated to the audit committee and that (1) relates to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective, or complex auditor judgment
Which of the following statements concerning prospective financial statements is correct? a. only a financial forecast would normally be appropriate for limited use b. only a financial projection would normally be appropriate for general use c. any type of prospective financial statement would normally be appropriate for limited use d. any type of prospective financial statement would normally be appropriate for general use
any type of prospective financial statement would normally be appropriate for limited use
Example of risk assessment procedures to obtain an understanding
as part of preliminary analytical procedures, calculate inventory turnover and compare it to prior periods. unusual or unexpected trends may indicate inventory valuation or obsolescence issues
Auditor's responsibility [AICPA's SAS 132]
assess management's evaluation and disclosures. make a separate assessment of the company's going concern status *if substantial doubt, add a going concern paragraph to the audit report*
Test of controls
audit procedures performed to test the operating effectiveness on control in preventing, or detecting and correcting, material misstatements at the relevant assertion level identify the control that should be in place, then figure out how to test it
Purchasing process typical transaction: Incur operating expense
balance sheet: A/P or accrued liability income statement: operating expense
Purchasing process typical transaction: Purchase inventory
balance sheet: A/P; inventory (or purchase) income statement: none
Purchasing process typical transaction: Cash disbursement
balance sheet: cash; A/P or Accrued liability
Purchasing process typical transaction: Prepaids-consume
balance sheet: prepaid asset income statement: operating expense
Criminal liability
be aware that auditors can be held criminally liable under the laws discussed in the previous section. Criminal prosecutions require that some form of criminal intent be present, such as gross negligence or fraud
On receiving the cutoff bank statement, the auditor should vouch a. deposits in transit on the year-end bank reconciliation to deposits in the cash receipts journal b. checks dated before year-end listed as outstanding on the year-end bank reconciliation to the cutoff statement c. deposits listed on the cutoff statement to deposits in the cash receipts journal d. checks dated after year-end to outstanding check listed on the year-end bank reconciliation and to the cutoff statement
checks dated before year-end listed as outstanding on the year-end bank reconciliation to the cutoff statement
Revenue transaction controls: chart of accounts
classification
Example of tests of controls
client control: all purchases greater than $500 require department head pre-approval test: for a sample of 20 cash disbursements GT $500, examine supporting documentation. Verify presence of purchase order giving department head's pre-approval for the purchase
Tracy corp. was the defendant in a lawsuit that was settled on Feb. 1, 20X2 for $1.5 million. The suit originated in early 20X1, and Tracy accrued a $1.2 million liability as of 12/31/X1
company: adjusts the 12/31/X1 financial statements --> type 1 revise estimate and add $300,000
Lookback testing #1
compare last year's estimate to actual outcomes to assess how good management's estimate was. this gives insight into how good management's current estimate is likely to be
Which of the following procedures would an auditor most likely rely on to verify management's assertion of completeness? a. reviewing standard bank confirmations for indications of cash manipulations b. comparing a sample of shipping documents to related sales invoices c. observing the entity's distribution of payroll checks d. confirming a sample of recorded receivable by direct communication with the debtors
comparing a sample of shipping documents to related sales invoices
No level of assurance
compilation --> management provides information; no testing performed consulting/management advisory/tax --> accountant assists the client in completing a task
Audit evidence can come in different forms with different degrees of reliability. Which of the following is the most persuasive type of evidence? a. bank statements obtained from the entity b. computations made by the auditor c. prenumbered entity sales invoices d. vendors' invoices included in the entity's files
computations made by the auditor
The four principles of the IIA Code of Ethics are a. confidentiality, competency, objectivity, and integrity b. objectivity, independence, compliance, and due diligence c. honesty, integrity, independence, and competency d. integrity, confidentiality, independence, and compliance
confidentiality, competency, objectivity, and integrity
Obtaining a letter from the entity's attorney indicating that there were no lawsuits in progress against the entity.
confirmation
Determine which of the two would provide evidence that is more reliable. confirming an account balance with a bank OR examining the client's bank statement
confirming an account balance with the bank because it is a 3rd party
To establish the existence and rights of a long-term investment in the common stock of a publicly traded company, an auditor ordinarily performs a security count or a. relies on the entity's internal controls if the auditor has reasonable assurance that the control activities are being applied as prescribed b. confirms the number of shares owned that are held by an independent custodian c. determines the market price per share at the balance sheet date from published quotations d. confirms the number of shared owned with the issuing company
confirms the number of shares owned that are held by an independent custodian
there is inadequate segregation of duties
control risk
Purchase: design a test of controls that tests the VA-ACCURACY (AUTHORIZATION) assertion for purchases
control that should be in place: requisition and purchase order system is used, whereby purchases over $500 require prior department approval before item can be purchased test by selecting a sample of entries in the purchase journal over the $500 limit. Verify presence of approved purchase order
Entity-level controls
controls that have a pervasive effect on the entity's system of internal control; also referred to as company-level controls
Which of the following controls would most likely be testing during an interim period? a. controls over non-routine transactions b. controls over period-end financial reporting process c. controls that operate on a continuous basis d. controls over transactions that involve a high degree of subjectivity
controls that operate on a continuous basis
Entity-level controls can have a pervasive effect on the entity's ability to meet the control criteria. Which one of the following is not an entity-level control? a. controls to monitor results of operations b.management's risk assessment process c. controls to monitor the inventory taking process d. the period-end financial reporting process
controls to monitor the inventory taking process
Auditor's assessment of client's control is bad and true state of client's control is bad
correct decision
Bill and hold
customer order number. Set inventory aside but unable to take delivery, go ahead and bill the customer and set aside for when they are ready to receive. the seller sets the inventory aside without actual number to manipulate financial statements
Typical purchase transaction controls: receiving reports reflect date received; receiving reports forwarded daily to accounts payable for immediate recording
cut-off
Which of the following combinations results in the greatest decrease in sample size in an attribute sample for a test of controls? Desired confidence level, Tolerable deviate rate, expected population deviation rate a. decrease, decrease, increase b. increase, increase, decrease c. decrease, increase, decrease d. decrease, increase, increase
decrease, increase, decrease
Auditing Fair Value of Investments: Level 2
description: no active market for the security, but market data for similar items is available valuation method: mark to matrix of similar security values
Which of the following is not a Trust Services principle? a. processing integrity b. privacy c. digital certificate authorization d. availability
digital certificate authorization
The company has not taken any new debt in the current year, nor made any changes to the existing debt, so all debt currently on the balance sheet was subjected to audit procedures in the prior year. The company's controls over debt are strong, and you do not anticipate misstatements in the account balance. Hence, this account is deemed to be lower than average risk.
either increase tolerable misstatement or leave it the same
A written understanding between the auditor and the entity concerning the auditor's responsibility for fraud is usually set forth in a(n) a. internal control letter b. letter of audit inquiry c. management letter d. engagement letter
engagement letter
In a properly designed accounts payable system, a voucher is prepared after the invoice, purchase order, requisition, and receiving report are verified. The next step in the system is a. cancellation of the supporting documents b. entry of the check amount in the check register c. entering of the voucher into the voucher register d. approval of the voucher for payment
entering of the voucher into the voucher register
interview management to determine whether any of the company's accounts receivable have been pledged as collateral or assigned
evidence type: inquiry assertion: rights and obligations
Which audit procedures goes well with this specific assertion? Verify that inventory has been reduced, when appropriate, to replacement cost or net realizable value (valuation)
examine current vendor price lists
What concerns about inventory transactions and balances pairs with the authorization assertion?
excess inventory (possibility obsolete) from unauthorized production/pruchasing
Assertions
expressed or implied representations by management regarding the recognition, measurement, presentation, and disclosure of information in the financial statements and related disclosures
What concerns about inventory transactions and balances pairs with the existence/occurrence assertion?
fictitious inventory; recorded but not on hand (theft)
Can a 3rd party sue the auditor under tort law?
fraud and gross negligence --> generally all 3rd parties may sue the auditor ordinary negligence --> ability of 3rd parties to sue the auditor is limited to parties to whom the auditor owed a duty of care (rules vary based on jurisdiction)
An auditor anticipates assessing control risk at a low level in an IT environment. Under these circumstances, on which of the following controls would the auditor initially focus? a. data capture controls b. application controls c. output controls d. general controls
general controls
Revenue process- Income Statement: Common Analytical Procedures
gross margin by product line sales per square foot of brick and mortar retail space bad debt expense as a percentage of sales sales returns as a percentage of sales estimation of sales commissions based on commission rate
In which of the following circumstances would an auditor usually choose between issuing a qualified opinion or a disclaimer of opinion on a client's financial statements? a. departure from general accepted accounting principles b. inadequate disclosure of accounting policies c. inability of the auditor to obtain sufficient appropriate evidence d. unreasonable justification for a change in accounting principle
inability of the auditor to obtain sufficient appropriate evidence
Which of the following would most likely be an advantage in using classical variables sampling rather than monetary-unit sampling? a. an estimate of the standard deviation of the population's recorded amounts is not required b. the auditor rarely needs the assistance of a computer program to design an efficient sample c. inclusion of zero and negative balances generally does not require special design considerations d. any amount that is individually significant is automatically identified and selected
inclusion of zero and negative balances generally does not require special design considerations
Which of the following would most likely be an internal control activity designed to detect errors and fraud concerning the custody of inventory? a. periodic reconciliation of work in process with job cost sheets b. segregation of functions between general accounting and cost accounting c. independent comparisons of finished goods records with counts of goods on hand d. approval of inventory journal entries by the storekeeper
independent comparisons of finished goods records with counts of goods on hand
Cash is more susceptible to theft than an inventory of coal.
inherent risk
Risk of material misstatement refers to a combination of which two components of the audit risk model? a. audit risk and inherent risk b. audit risk and control risk c. inherent risk and control risk d. control risk and detection risk
inherent risk and control risk
Determine which of the two would provide evidence that is more reliable. inspection of a bank statement received by the client OR inspection of a duplicate shipping document maintained in the client's shipping file
inspection of bank statement because dupblicates are not as reliable and external vs. internal
Tracing the prices used by the entity's billing program for pricing sales invoices to the entity's approved price list.
inspection of records or documents OR reperformance
Examining a new plastic extrusion machine to ensure that this major acquisition was received.
inspection of tangible assets
What concerns about inventory transactions and balances pairs with the completeness assertion?
inventory is not recorded; inventory out on consignment is not properly included
What concerns about inventory transactions and balances pairs with the VA-cutoff assertion?
inventory transactions are not recorded in the wrong period
An independent audit adds value to the communication of financial information because the audit a. confirms the exact accuracy of management's financial representation b. lends credibility to the financial statements c. guarantees that financial data are fairly presented d. assures that readers of financial statements that any fraudulent activity has been corrected
lends credibility to the financial statements
Which of the following is correct regarding the types of audits over which the ASB and the PCAOB, respectively, have standard-setting authority in the United States? ASB, PCAOB a. nonpublic company audits, nonpublic company audits b. public company audits, public company audits c. nonpublic company audits, public company audits d. public company audits, nonpublic company audits
nonpublic company audits, public company audits
Which of the following audit procedures is ordinarily performed last? a. obtaining a management representation letter b. reading the minutes of directors' meetings for evidence of authorization of acquisition of fixed assets c. requesting a legal letter d. confirming accounts payable
obtaining a management representation letter
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "we conducted out audits in accordance with auditing standards generally accepted in the United States of America"
only in a report prepared under the AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a heading: "Auditor's responsibility"
only in a report prepared under the AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "our report on Ace Corp.'s internal control over financial reporting, dated February 15, 20XX, expresses an unqualified opinion"
only in a report prepared under the PCAOB reporting guidance --> end of opinion on financial statements section
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a title: "reporting of independent registered public accounting firm"
only in a report under the PCAOB reporting guidance
In a jurisdiction that follows the Ultramares (strict privity) doctrine, which third parties have standing to sue an auditor for ordinary negligence?
only third parties NAMED in the contract
Major functions within the revenue process
order entry credit authorization shipping billing cash receipts accounts receivable general ledger
Authorization assertion: the company takes delivery of goods that were not ordered, an unauthorized purchase is made, purchase is made from a new vendor or at a price that is not the company's usual price
people in receiving department need open access to purchase order. approve acquisitions consistent with entity's authorized dollar amount, approved purchase requisition, and purchase order. people in purchasing department need authorized approval. lists of approved vendors/price to generate purchase orders
Purchase: design a test of transactions that tests the VA-CUTOFF assertion for purchases
population: receiving reports select a sample of receiving reports. for reports representing purchases made FOB destination, verify that the date on the receiving report agrees to the date recorded in the purchases journal
a common example is comparing high-level inventory turnover to prior year for indications of inventory build-up or obsolescence
preliminary
Final analytical procedures are generally intended to a. provide the auditor with a final, overall evaluation of the relationships among financial statement balances b. test transactions to corroborate management's financial statement assertions c. gather evidence concerning account balances that have not yet been investigated d. retest control activities that appeared to be ineffective during the assessment of control risk
provide the auditor with a final, overall evaluation of the relationships among financial statement balances
Which of the following is not a part of the role of internal auditors? a. assisting the external auditors b. providing reports on the reliability of financial statements to investors and creditors c. consulting activities d. operational audits
providing reports on the reliability of financial statements to investors and creditors
Purchasing process- Common analytical procedures for purchasing process on income statement
reasonableness test for various operating expense accounts (comparison to prior year)
Substantive analytical procedure for investments
reasonableness tests for ending balances, interest income, and dividend income
Expected population deviation rate
relationship to sample size: direct
Agreeing the total of the accounts receivable subsidiary ledger to the accounts receivable general ledger account.
reperformance OR inspection of records and documents
After accounting for a sequence of inventory tags, an auditor traces a sample of tags to the physical inventory listing to obtain evidence that all items a. included in the listing have been counted b. represented by inventory tags are included in the listing c. included in the listing are represented by inventory tags d. represented by inventory tags are bona fide
represented by inventory tags are included in the listing
Which of the following audit procedures is most likely to assist an auditor in identifying conditions and events that may indicate substantial doubt about an entity's ability to continue as a going concern? a. review compliance with the terms of debt agreements b. review management's plans to dispose of assets c. evaluate management's plans to borrow money or restructure debt d. consider management's plans to reduce or delay expenditures
review compliance with the terms of debt agreements
Which audit procedures goes well with this specific assertion? Verify that the major categories of inventory and their bases of valuation are adequately reported in the financial statements (completeness and accuracy and valuation for presentation and disclosure)
review drafts of the financial statements
Which audit procedure goes well with this specific assertion? Ensure that the entity has legal title to inventory (rights and obligations)
review loan agreements and minutes of board directors' meetings
The audit of year-end physical inventories should include steps that verify that the entity's purchases and sales cutoffs were adequate. The audit steps should be designed to ensure that merchandise included in the physical count at year-end was NOT recorded as a: a. purchase return in the subsequent period b. purchase in the current period c. sale in the current period d. sale in the subsequent period
sale in the current period
statistical sampling
sampling that uses the laws of probability to select and evaluate the results of an audit sample, thereby permitting the auditor to quantify the sampling risk for the purpose of reaching a conclusion about the population
Which of the following audit procedures is best designed to test the accuracy assertion for inventory? a. examine current vendor price lists b. select a sample of items recorded in the inventory compilation, and examine supporting vendor invoices c. select a sample of items present during the physical inventory count, and determine that they have been included on count tags d. select a sample of items recorded on count tags, and verify that the items are on hand during the inventory count
select a sample of items recorded in the inventory compilation, and examine supporting vendor invoices
Which audit procedures goes well with this specific assertion? Verify that the cost of inventory has been properly determined (accuracy)
select a sample of recorded items and examine supporting vendor invoices and contracts
The primary evidence regarding year-end bank balances is documented in the a. standard bank confirmations b. outstanding check listing c. interbank transfer schedule d. bank deposit lead schedule
standard bank confirmations
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy client lacks controls over PPE acquisitions
substantive
Material price test
test the quantity and type of materials included in the product and the price of the materials
Specific audit procedures conducted near completion of audit: obtain written representation from management
that all litigation, asserted and unasserted claims, and assessments have been disclosed in accordance with SFAS5 and ASC450
In classical variables sampling, which of the following must be known in order to estimate the appropriate sample size required to meet the auditor's needs in a given situation? a. the qualitative aspects of misstatements b. the total dollar amount of the population c. the acceptable level of risk d. the estimated percentage of deviations in the population
the acceptable level of risk
Tolerable misstatement
the amount of planning materiality that is allocated to a financial statement account
The assurance bucket is filled with all of the following types of evidence except: a. test of controls b. the audit report c. substantive analytical procedures d. test of details
the audit report
Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because a. a majority of recipients usually lack the willingness to respond objectively b. some recipients may report incorrect balances that require extensive follow-up c. the auditor cannot infer that all non respondents have verified their account information d. negative confirmations do not produce evidence that is statistically quantifiable
the auditor cannot infer that all non respondents have verified their account information
Which of the following best describes the auditor's responsibility for "other information" included in the annual report to stockholders that contains financial statements and the auditor's report? a. the auditor has no obligation to read the "other information" b. the auditor has no obligation to corroborate the "other information" but should read the "other information" to determine whether it is materially consistent with the financial statements c. the auditor should extend the examination to the extent necessary to verify the "other information" d. the auditor must modify the auditor's report to state that the other information "is un-audited" or "is not covered by the auditor's report"
the auditor has not obligation to corroborate the "other information" but should read the "other information" to determine whether it is materially consistent with the financial statements
The Sarbanes-Oxley Act of 2002 requires management to include a report on the effectiveness of ICFR in the entity's annual report. It also requires auditors to report on the effectiveness of ICFR. Which of the following statements concerning these requirements is false/ a. the auditor should evaluate whether internal controls over financial reporting are designed and operating effectively b. management's report should state its responsibility for establishing and maintaining an adequate internal control system c. management should identify material weaknesses in its report d. the auditor should provide recommendations for improving internal control in the audit report
the auditor should provide recommendations for improving internal control in the audit report
Reliance strategy
the auditor's decision to rely on the entity's controls, test those controls, and reduce the direct tests of the financial statement accounts
Professionalism
the conduct, aims, or qualities that characterize or mark a profession or a professional person
Which of the following statements best describes the role of materiality in a financial statement audit? a. materiality refers to the "material" from which audit evidence is developed b. the higher the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather c. the lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather d. the level of materiality has no bearing on the amount of evidence the auditor must gather
the higher the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather
Which of the following most likely represents a weakness in internal control of an IT system? a. the system analyst reviews output and controls the distribution of output from the IT department b. the accounts payable clerk prepares data for computer processing and enters the data into the computer c. the systems programmer designs the operating and control functions of programs and participates in testing operating systems d. the control clerk establishes control over data received by the IT department and reconciles control totals after processing
the systems programmer designed the operating and control functions of programs and participates in testing operating systems
Which type of test and management assertions goes with this test? For a random sample of check disbursements, determine that the vendor's invoice is mathematically correct, quantity billed agrees to the amount of product received per the receiving report, and that the invoice total agrees to the check total
type of test: Substantive test of transactions management assertion: accuracy
An auditor's flowchart of an entity's accounting system is a diagrammatic representation that depicts the auditor's a. program for test of controls b. understanding of the system c. understanding of the types of fraud that are probable, given the present system d. documentation of the study and evaluation of the system
understanding of the system
Which of the following is most likely to be detected by an auditor's review of an entity's sales cutoff? a. unrecorded sales for the year b. lapping of year-end accounts receivable c. excessive sales discounts d. unauthorized goods returned for credit
unrecorded sales for the year
Attribute Sample
used to estimate the proportion of a population that posses a specified characteristic the most common use is for test of controls, where the characteristic of interest is that the control is not effective EXAMPLE: client's controls require that an approved purchase order must be present before a check can be issued for a purchase Attribute sampling could be used to test whether this control is effective by examining the deviation rate (percentage of the time that the control is not working effectively)
roll forward schedules
used to track and test the changes in an account balance from the beginning of the year to the end of the year OR from the completion of interim testing to the end of the year
Audit Data Analytics
using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit
Inquiries of warehouse personnel concerning possibly obsolete or slow-moving inventory items provide assurance about management's assertion of a. completeness b. existence c. presentation d. valuation
valuation
Assets and revenues are based on significant estiamtes that involve judgments and undertainties that are difficult to corroborate
Opportunities
Foreseen 3rd parties (restatement of torts and Rusch factors)
NAMED AND KNOWN plus person or limited group of persons whose reliance on the financial statements was FORESEEN by the auditor
Reasonably foreseeable 3rd parties (Rosenblum)
NAMED, KNOWN, and FORESEEN plus all third parties whose reliance was REASONABLY FORESEEABLE by the auditor
Corporate governance
The oversight mechanisms in place to help ensure the proper stewardship over an entity's assets. Management and the board of directors play primary roles, and the independent auditor plays a key facilitating role.
Communicating fraud findings
-to management (at appropriate level) -to the audit committee -to external parties (limited basis because of confidentiality issues) -regulators, successor auditors, subpoena
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. ...projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate...
definition and limitations of ICFR
As lower acceptable levels of both audit risk and materiality are established, the auditor should plan more work on individual accounts to a. find smaller errors b. find larger errors c. increase the tolerable misstatements in the accounts d. decrease the risk of over reliance
find smaller errors
CUDR < TOLERABLE
supports planned reliance on control initial control risk assessment is supported planned level of substantive testing of balances should be performed
Business risks
Risks resulting from significant conditions, events, circumstances, and actions or in-actions that could adversely affect management's ability to execute its strategies and to achieve its objectives, or through the setting of inappropriate objectives or strategies.
Type 2 Event
-new conditions- DID NOT exist at the balance sheet date -require disclosure, but not adjustment -auditor may add emphasis paragraph in auditor's report to emphasize the matter
There are recurring attempts by management to justify marginal or inappropriate accounting on the basis of that the dollar impact is not material
attitudes/rationalization
Suits against auditors under section 11 of the 1933 Securities Act are generally restricted t which shareholders?
original shareholders who purchased their securities in an IPO
Authorization assertion: a shipment is made to a customer on account, but the customer's credit limit is not adequate to cover this purchase
built in credit order so shipping order doesn't get to shipping until authorized process is in place (verify credit limit)
Which type of test and management assertion goes with this test? Obtain the accounts payable subsidiary ledger as of the balance sheet date. Foot and trace the total to the general ledger
type of test: test of details of balances management assertion: accuracy --> tie-in
Type of liability: federal statues (1933 and 1934 acts)
typical plaintiffs: client and third parties
Tests of details of account balances and disclosures
Tests that concentrate on the details of amounts contained in an account balance and related footnotes
Substantive tests of transactions
Tests to detect errors or fraud in individual transactions.
Sampling risk
The possibility that the sample drawn is not representative of the population and that, as a result, the auditor reaches an incorrect conclusion about the reliability of the control, the account balance, or class of transactions based on the sample.
Risk of material misstatement
The pre-audit risk that the entity's financial statements contain a material misstatement whether caused by error or fraud.
Compilation of financial statements
The presentation, in the form of financial statements, of information that is the representation of management or owners without undertaking to express any assurance on the statements.
Lapping
The process of covering a cash shortage by applying cash from one customer's accounts receivable against another customer's accounts receivable.
Risk assessment process
The process through which management of an entity identifies, plans for, and controls the possible threats to achieving the entity's objectives.
audit risk
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
Detection risk
The risk that the procedures performed by the auditor will not detect a misstatement that exists and that could be material, either individually or in combination with other misstatements.
Risk of incorrect rejection
The risk that the sample supports the conclusion that the control is not operating effectively when it actually is or that the recorded account balance is materially misstated when it is not materially misstated.
Risk of incorrect acceptance
The risk that the sample supports the conclusion that the control is operating effectively when it is not or that the recorded account balance is not materially misstated when it is materially misstated.
Audit evidence
-information used by the auditor as the basis for the audit opinion issued -each of the management assertions is tested through the collection and analysis of audit evidence
Audit procedures to look for subsequent events
-inquire of management -read minutes of meetings -inquire of legal counsel -examine the books of original entity -read interim financial statements -evaluate procedures for identifying subsequent events
CMA - Certified Management Accountant
-institute of management accountants (IMA)
SOX 2002
-instituted changes that affect the corporate governance structures of PUBLIC companies -required audit of ICFR for public companies -created the PCAOB -gave PCAOB authority to promulgate auditing standards for audits of PUBLIC companies -gave PCAOB authority to review and discipline auditors of PUBLIC companies
Issues affecting reliability of evidence
-internal (100% within client) vs. External (has existed outside client and been subjected to verification) -independence of source -auditor's direct knowledge -written vs. verbal -original vs. photocopy -strength of client's IC (when determining reliability of internal documents)
What is the primary difference between the common law concepts of "ordinary negligence" and "gross negligence/constructive fraud"
-ordinary negligence is lack of reasonable care -gross negligence is lack of any care (recklessness)
What is auditing and why is it valuable?
-origins -agency problem 1. information asymmetry and information risk 2. users need reliable information 3. management needs to be monitored -house inspector analogy 1.similarities to audit context 2.major difference from audit context
Types of audit sampling: auditing standards recognize and permit statistical and non-statistical methods Statistical sampling
-uses laws of probability to compute sample sizes and evaluate results -most efficient sample sizes -able to quantify allowance for sampling risk
Commitments
-usually identified through inquiry of client personnel and review of board minutes and contracts -in most cases, commitments are disclosed in a footnote to the financial statements (cannot cancel arrangement without penalty) -may also require an adjustment to OCI
general price test
-verify unit costs to vendor invoices -determine that client's cost flow assumption is applied correctly -test complex calculations (dollar value LIFO)
An audit document that reflects the major components of an amount reported in the financial statements is referred to as a(n) A. Lead schedule B. Supporting schedule C. Audit control account D. Working trial balance
lead schedule
Which audit procedure matches with this assertion: ensure that the allowance for uncollectible accounts is properly stated (accuracy, valuation, and allocation)
review of aging of accounts receivable with the credit manager
Which audit procedure matches with this assertion: ensure that the entity has legal title to accounts receivable (rights and obligations)
review of bank confirmations and loan agreements
Blank or zero-balance (positive) confirmation
A confirmation request on which the receipt fills in the amount or furnishes the information requested
Control deficiency
A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent, or detect and correct, misstatements on a timely basis.
Attest services
Services provided by a practitioner engaged to issue a report on subject matter, or an assertion about subject matter, that is the responsibility of another party. Encompasses financial statement audits.
What is the purpose of an audit?
Purpose and premise, principle 1 -enhance user confidence
What are management's responsibilities with respect to the financial statements?
Purpose and premise, principle 2 -prepare financial statements in accordance with GAAP and free of MM
SEC Independence Rules: Communication
-audit committee is the audit client. Auditor reports directly to the Audit Committee. Audit committee must approve of all permitted non-audit services -fees paid tot eh auditor for the audit and other serves must be disclosed
Sampling as a component of the audit (1/2)
-auditing standards recognize and permit both statistical and non-statistical methods of audit sampling -two technological advances have reduced the number of times auditors need to apply sampling techniques to gather audit evidence 1. development of well-controlled, automated accounting systems 2. powerful audit software to download and examine entire populations of data
Significant deficiency
A deficiency, or a combination of deficiencies, in internal control that is less severe than a material weakness yet important enough to merit attention by those charged with governance.
Which of the following best describes relationships among auditing, attest, and assurance services? a. attest is a type of auditing service b. auditing and attest services represent two distinctly different types of services - there is no overlap c. auditing is a type of assurance service d. assurance is a type of attest service
auditing is a type of assurance service
CUDR > TOLERABLE
does NOT support planned reliance on control initial control risk assessment is NOT supported revise (raise) CR assessment planned level of substantive testing of balances should be revised (increased) accordingly
What is the primary different between the common law concepts of "fraud" and "gross negligence/constructive fraud"
fraud indicates knowledge of a falsehood and intent to deceive (scienter) constructive fraud indicates reckless actions, but without actual knowledge of a falsehood and intent to deceive
Indicate in which report, or in which section, each item would appear "the financial statements....present fairly, in all material respects..."
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance
Under the SEC's rules regarding independence, which of the following must an entity disclose? a. only fees for the external audit b. only fees for internal and external audit services provided by the audit firm c. fees for the external audit, audit-related fees, tax fees, and fees for other non audit services performed by the audit firm d. only fees for systems implementation and design and non audit services performed by the audit firm
fees for the external audit, audit-related fees, tax fees, and fees for other non audit services performed by the audit firm
Indicate in which report, or in which section, each item would appear Contains headings throughout the report
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "our responsibility is to express an opinion...based on our audits"
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance
perpetual inventory system
inventory and COGS are continually updated; physical count happens at the end of the period to make any needed book-to-physical adjustment to inventory
Which of the following control activities would be most likely to assist in reducing the control risk related to the occurrence of inventory transactions> a. inventory manager does not have ability to record inventory transactions b. summary of the receiving reports is independently compared to the inventory status report c. inventory is periodically reviewed for slow-moving or obsolete items, which may require a write-down d. subsidiary ledgers are periodically reconciled with inventory control accounts
inventory manager does not have ability to record inventory transactions
What concerns about inventory transactions and balances pairs with the VA-classification assertion?
inventory no properly classified among raw materials, work in process, or finished goods
What concerns about inventory transactions and balances pairs with the rights and obligations assertion?
inventory owned by others is improperly included (consignments, bill and hold, collateral)
The Public Company Accounting Oversight Board a. is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies b. is a quasi-governmental organization that has legal authority to set accounting standards for public companies c. is a quasi-governmental organization that has a policy to ignore public comment and input in the process of setting auditing standards d. is a quasi-governmental organization that is independent of the SEC in setting auditing standards
is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies
An auditor includes a separate paragraph in an otherwise unmodified financial statement audit report to emphasize that the entity being reported upon had significant transactions with related parties. The inclusion of this separate paragraph a. is appropriate and would not negate the unmodified opinion b. is considered an "except for" qualification of the opinion c. violates auditing standards if this information is already disclosed in footnotes to the financial statements d. necessitates a revision of the opinion paragraph to include the phrase "with the foregoing explanation"
is appropriate and wold negate the unmodified opinion
Which of the following statements best describes what is meant by an unqualified audit opinion? a. issuance of unqualified auditor's report indicates that in the auditor's opinion the client's financial statements are not fairly enough presented in accordance with agreed-upon criteria to qualify for a clean opinion b. issuance of an unqualified auditor's report indicates that the auditor is not qualified to express an opinion that the client's financial statements are fairly presented in accordance with agreed-upon criteria c. issuance of an unqualified auditor's report indicates that the auditor is expressing different opinions on each of the basic financial statements regarding whether the client's financial statements are fairly presented in accordance with agreed-upon criteria d. issuance of a standard unqualified auditor's report indicates that in the auditor's opinion of the client's financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases
issuance of a standard unqualified auditor's report indicates that in the auditor's opinion of the client's financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases
How as Gyders able to cover the theft of cash receipts for an extended period of time?
lack of oversight compensating control for poor segregation of duties should be an involved manager/owner
An auditor would be most likely to identify a contingent liability by obtaining a(n) a. accounts payable confirmation b. bank confirmation of the entity's cash balance c. letter from the entity's general legal counsel d. list of subsequent cash receipts
letter from the entity's general legal counsel
VA-Accuracy assertion: a customer ordered and is billed for blue widgets, but green widgets were actually shipped
match sales invoice/customer number order to shipping documents. customer order becomes basis to shipping department. have someone double check or use bar-codes and scanning, to validate what was ordered is actually being shipped
gathering evidence during the post-balance sheet period lets the auditor do what
use the advantage of hindsight, evidence collected between the balance sheet date and the date of the auditor's report
Audit data analytics
using analysis, modeling, and visualization to discover and analyze patterns, anomalies, and other information in data in the context of the audit
Johnson & Johnson, CPAs, were sued by shareholders of Clark Corp., an audit client, for losses sustained after purchasing Clark Stock in an IPO. Although the financial statements were not found to be misstated, Johnson & Johnson has suffered from the effects of negative publicity associated with the litigation
engagement risk
Revenue: design a test of substantive analytical procedures that tests the VA-ACCURACY assertion for sales commissions
estimate sales commissions expense by calculating sales revenue*commission rate
Which of the following is not one of the general areas of the IIA's International Standards for the Professional Practice of Internal Auditing? a. performance standards b. implementation standards c. ethical standards d. attribute standards
ethical standards
Which of the following is likely to be the most effective audit procedure for verifying dividends earned on investments in publicly traded equity securities? a. trace deposits of dividend checks to the cash receipts book b. reconcile recorded earnings with the dividend earnings reported in the investment broker statement c. compare the amounts received with prior-year dividends received d. recompute selected extensions and footings of dividend schedules and compare totals to the general ledger
reconcile recorded earnings with the dividend earnings reported in the investment broker statement
Which of the following most directly represents the occurrence assertion for inventory? a. all inventory was recorded b. purchase requisitions were initiated by appropriate personnel c. inventory was properly accumulated from journals and ledgers d. recorded inventory transactions actually happened
recorded inventory transactions actually happened
An auditor would be least likely to use confirmations in connection with the examination of a. inventory held for a third-party warehouse b. refundable income taxes c. long-term debt d. stockholder's equity
refundable income taxes
Population size
relationship to sample size: direct, but only when population size is small (fewer than 500 items)
Standard unqualified audit report for a public company
-Title: independent and registered -Addressee: typically stockholders and board of directors or audit committee; NOT generally addressed to management -Key content of the main body of the report 1. opinion on the financial statements: identifies information that was audited (names each statement, typically 2 years of balance sheet and income statement, cash flows, stockholders equity, and notes), fairly in all material respects, opinion whether financial statements conform to U.S. GAAP, additional paragraph references audit of ICFR, if applicable 2. basis for opinion: responsibilities of management and the auditor, registration with the PCAOB, independence requirement, standards of PCAOB (US) for conducting the audit -describes what the audit entails 1. obtain reasonable assurance 2. free of material misstatement, error or fraud 3. assess RMM, whether error or fraud 4. test basis, evidence, accounting principles, significant estimates, reasonable basis
An "integrated audit"
-each audit provides relevant information about the other. e.g. if the ICFR audit determines that controls over payroll are ineffective, this can inform the financial statement audit to use a substantive strategy, rather than a reliance strategy, in the payroll expense area -BUT each audit (and its supporting work papers) must also stand on its own. e.g. substantive testing of PPE in the financial statement audit finds no material misstatements. However, this does not mean that PPE controls are actually effective. The ICFR audit must still document and these these controls.
SOX Section 404 Requires the annual report of every public company to include information on internal controls Management's report
-management accepts responsibility for the company's ICFR -assesses the effectiveness of ICFR (based on management's own evaluation and testing)
Auditor's view of his/her role
-conduct the audit in accordance with GAAS/PCAOB standards -give opinion on whether financial statements are fairly stated in conformity with GAAP (no material misstatements)
Confidential Rule
-confidential client information can not be disclosed without specific client consent EXCEPTIONS- (no client consent required) 1. to satisfy professional obligations (disclosure and performance requirements of GAAP and GAAP) under the "compliance with standards" rule 2. to comply with subpoena or laws and regulations (note that some jurisdictions now have laws creating accountant-client privilege, allowing the client to prevent the CPA from testifying) 3. to comply with AICPA or State Board review the professional practice 4. to comply with AICPA or State Board ethics, investigative, or disciplinary review 5. review of the member's professional practice in conjunction with a prospective sale, as long as appropriate precautions are taken to ensure confidentiality
Typical tests of the cash balance
-confirm balance with bank; test client's bank reconciliation -fraud-related procedures (if additional procedures deemed necessary) -testing of petty cash
Should we accept this engagement? Reevaluate continuing clients periodically
-conflicts over accounting/auditing issues -conflicts over fees -changes to the client's business -changes affecting independence
If higher RMM due to fraud exists
-consider enhancing staffing and supervision -change up the audit procedures to minimize predictability -beef up testing in higher risk areas
Final evaluation of results
-consider materiality of detected misstatements (1) revisit materiality determinations from planning (1.1) are actual results of operations for the year similar in size to the projected benchmarks used at planning to determine planning materiality? (2) quantitative and qualitative considerations (3) significance individually and in the aggregate (4) impact on financial statement component totals (total assets, total liabilities, total SE, revenues, expenses, NI) (5) known misstatements vs likely misstatements and differences in estimates
Importance of Professionalism in Accounting
-consider the product that is being sold and how it is valued - importance of public trust and confidence -reputation as a means of distinguishing the quality of the product
Information and Communication
-consists of hardware, software, people, procedures, and data -an effective accounting information system should do the following transactions: 1. identify and record all valid transactions 2. describe them with sufficient detail and timeliness to allow proper classification 3. measure them so they can be reported at the proper monetary value in the financial statements 4. record in correct time period 5. properly present and disclose in the financial statements -Principles include 1. production and use of quality information 2. communication of information internally 3. communication of information externally
Permanent files
-corporate charter -chart of accounts -organization chart -important contracts -internal control documentation -terms of stock and bond issues -prior years' analytical procedures
Typical incompatible areas in the sales process
-credit authorization and order entry -shipping and billing -cash receipts and maintaining A/R records
Discussion of data analytics
-data analytic techniques become more sophisticated, audit firms are beginning to use them to replace "traditional sampling" in some areas of the audit e.g. analyze the entire population on very specific criteria, in order to identify a few questionable/suspicious items for further investigation -however, data analytics can not entirely replace the need for sampling, so sampling continues to be an important aspect of auditing
Key Disadvantages/Limitations of MUS
-designed mainly to test for OVERstatements (but with some adjustments, can be used for understatements) -most appropriate for populations with low error rates -the selection of zero or negative balances in the sample generally requires special design consideration
Steps in MUS: Evaluation
-determined projected misstatement 1. a point estimate of the error in the population based strictly on the ratio in the sample 2. no allowance for sampling risk incorporated at this point -calculated upper misstatement limit (UML) 1. UML = proper misstatement + an allowance for sampling risk 2. calculated by the software -decision rule: compare UML to Tolerable Misstatement -1. as long as UML does not exceed tolerable, the test supports that the balance is not materially misstated 2. if UML > TOLERABLE, the results indicate that the balance is materially misstated
Key differences from statistical
-determining sample size 1. firms may use their own internal guidance (expected, tolerable, and confidence level are still considered) -selecting sample items 1. items should be selected without conscious bias, in a way that can be expected to represent to the population, haphazard is acceptable 2. "Random" method is permitted, but not required -evaluation (decision rule) 1. CUDR (or UML) can not be calculated; not possible to quantify the allowance for sampling risk 2. decision is based on comparing SFR to Expected and Tolerable deviation rates (or misstatements limits) 3. often "gray areas" in the interpretation
tort law concepts: ordinary negligence
-lack of reasonable care -clients can sue -3rd party ability to sue depends on jurisdiction-ultramares/credit alliance/restatement of torts/rosenblum
Statutory Liability
-major statutes that provide sources of liability for auditors 1. the securities act of 1933 2. the securities exchange act of 1934 3. Sarbanes-Oxley act of 2002 -enhances/toughens existing laws and penalties
Sampling risk
-the element of uncertainty that enters into the auditor's conclusions anytime sampling is used. -conclusion based on a sample might be different from the conclusion that would be reached if all items in the population were examined
Control activities
-the policies and procedures that help ensure that management's directives are carried out -physical controls -performance reviews/independent checks of performance -information processing controls 1. general (network, program changes, etc.) 2. application (authorization and accurate processing of individual transactions) -segregation of duties 1. authorization/recording/custody
typical incompatible areas in the purchasing process
-the purchasing function should be segregated from the requisition and receiving functions -the invoice-processing function should be segregated from the accounts payable function -the disbursement function should be segregated from the accounts payable function -the accounts payable function should be segregated from the general ledger function
Management assertions - auditing standards
-the specific guidance on these assertions depends on whether the client is a public or non-public company -AS NO. 1105 (PCAOB) guidance for public companies 5 basic assertions about the financial statements that need to be tested by the auditor 1. completeness 2. existence/occurrence 3. rights and obligations 4. presentation and disclosure 5. valuation/allocation
Fraud related audit procedures: bank transfer schedule
-to identify transfers of cash between bank accounts near year end that are suspicious or that were not recorded properly -may uncover kiting, other cash shortages, or control weaknesses (non-timely recording)
Substantive analytical procedures (required)
-to obtain evidence about particular assertions related to account balances or classes of transactions. -generally done at a detailed level
2. Determine materiality for individual accounts (Tolerable Misstatement or Performance Materiality)
-tolerable misstatement is the materiality allocated to an individual account -the level of tolerable misstatement for a given account helps the auditor set the scope of audit testing for that account -low tolerable misstatement means it is likely that more audit work will be done on that account -keep in mind: try to minimize costs, but still collect persuasive evidence
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy testing of the details of ending balances is deemed to be more efficient than performing a test of the underlying controls
substantive
a common example is an interest reasonableness test
substantive
The following table depicts the possible outcomes for the auditor's estimated computed upper deviation rate based on a sample relative to the auditor's tolerable deviation rate (i.e. the computed upper deviation rate will either be above or below the tolerable deviation rate). The table also depicts the two possible states of the actual population deviation rate compared with the auditor's tolerable deviation rate (the actual population deviation rate is unknown to the auditor). 1. Computed upper deviation rate is less than tolerable deviation rate, actual population deviation rate is less than tolerable deviation rate 2. Computed upper deviation rate exceeds tolerable deviation rate, actual population deviation rate is less than tolerable deviation rate 3. Computed upper deviation rate is less than tolerable deviation rate, actual population deviation rate exceeds tolerable deviation rate 4. Computed upper deviation rate exceeds tolerable deviation rate, actual population deviation rate exceeds tolerable deviation rate Suppose as a result of sample testing of controls, an auditor assess control risk higher than necessary given the actual (but unknown) population deviation rate and thereby increases substantive testing. This is illustrated by which of the four possible outcome conditions in the table above?
Computed upper deviation rate exceeds tolerable deviation rate, actual population deviation rate is less than tolerable deviation rate
Five small Chicago CPA firms have entered into an informal professional practice review arrangement. Each firm designates 2 partners to review the work of another firm- the items reviewed include audit working papers, tax returns, and financial statements. At the end of the process, the reviewers meet to discuss the strengths and weaknesses found. The firms do not obtain authorization from clients before the reviews take place. 1.700
Confidential Client Information Rule governs this practice *violation because information within work paper belongs to client (no reason to expose)* -need client to consult
Management advisory services
Consulting services that may provide advice and assistance concerning an entity's organization, personnel, finances, operations, systems, or other activities.
The AICPA Code of Professional Conduct: Part 1: Applies to Members in Public Practice
Contains Conceptual Framework, Rules and Interpretations 1. Rule topical areas 1.100 Integrity and Objectivity 1.200 Independence 1.300 General Standards 1.400 Acts Discretible 1.500 Fees 1.600 Advertising 1.700 Confidential Information 1.800 Form of an Organization and Name
The AICPA Code of Professional Conduct: Part 2: Applies to Members in Business
Contains Conceptual Framework, Rules and Interpretations 2. Rule Topical Areas 2.100 Integrity and Objectivity 2.300 General Standards 2.400 Acts Discretible
The AICPA Code of Professional Conduct: Part 3: Applies to Other Members
Contains Rules and Interpretations 3. Rule Topical Areas 3.400 Acts Discretible
The AICPA Code of Professional Conduct: Preface (Applies to all members)
Contains principles, definition, and interpretations 0.300 Principles (not enforceable) 0.020 Responsibilities 0.030 Public Interest 0.040 Integrity 0.050 Objectivity and Independence 0.060 Due Care 0.070 Scope and natures of services
Fees (1.500)
Contingent Fees Rule -fees based on the outcome of the engagement are not allowed for services to attest clients, or for tax return preparation Commissions and Referral Fees Rule -Commission Definition 1. fee received from third party for recommending product or service to a client 2. fee received for recommending client's product or service to a 3rd party --> prohibited if the client involved is an attest client --> permitted if the client involved is not an attest client and the commission arrangement is disclosed -Referral definition 1. a fee received for recommending or referring the services of another CPA to anyone 2. a fee paid to obtain a client --> permitted as long as fee is disclosed
Norm Nelson, CPA used a non-statistical sampling approach to perform a test of a client's inventory controls. The following information relates to the test. Control 1: -desired confidence: 95% -tolerable deviation rate: 7% -expected population deviation rate: 3% -sample size (determined judgmentally): 40 -number of deviations noted in testing: 1 Control 2: -desired confidence: 90% -tolerable deviation rate: 9% -expected population deviation rate: 4% -sample size (determined judgmentally): 20 -number of deviations noted in testing: 1
Control 1: rely -SDR= 2.5% (1/40) Control 2: conservative judgment -SDR= 5% (1/20)
Which control activity, assertion, and test are appropriate for this control? The payroll accounting system will not allow a check to be processed for an employee number that is not already in the employee master file.
Control activity: Information processing control - application Assertion: Authorization/existence Test: Sit with people in payroll and type in employee numbers in master file
Which of the following controls is most likely to help ensure that all credit revenue transactions of an entity are recorded? a. the billing department supervisor sends a copy of each approved sales order to the credit department for comparison to the customer's authorized credit limit and current account balance b. the accounting department supervisor independently reconciles the accounts receivable subsidiary ledger to the accounts receivable control account each month c. the accounting department supervisor controls the mailing of monthly statements to customers and investigates any differences reported by customers d. the billing department supervisor matches prenumbered shipping documents with entries in the sales journal
the billing department supervisor matches prenumbered shipping documents with entries in the sales journal
Which of the following presumptions is least likely to relate to the reliability of audit evidence? a. the more effective internal control, the more assurance it provides about the accounting data and financial statements b. an auditor's opinion is formed within a reasonable time to achieve a balance between benefit and cost c. evidence obtained from independent sources outside the entity is more reliable than evidence secured solely within the entity d. the independent auditor's direct personal knowledge obtained through observation and inspection is more persuasive than information obtained indirectly
an auditor's opinion is formed within a reasonable time to achieve a balance between benefit and cost
When auditing merchandise inventory at year-end, the auditor performs a purchase cutoff test to obtain evidence that a. all goods purchased before year-end are received before the physical inventory count b. no goods held on consignment for customers are included in the inventory balance c. goods observed during the physical count are pledged or sold d. all goods owned at year-end are included in the inventory balance
all goods owned at year-end are included in the inventory balance
Professional skepticism
an attitude that includes a questioning mind and a critical assessment of audit evidence. the auditor should not assume that management is either honest or dishonest
Legal letter
an audit inquiry sent to the entity's attorneys in order to obtain or corroborate information about litigation's, claims, and assessments
Which of the following statements concerning the auditor's use of statistical sampling is correct? a. an auditor needs to estimate the dollar amount of the standard deviation of the population in order to use classical variables sampling b. an assumption of monetary-unit sampling is that the underling accounting population is normally distributed c. a classical variables sample needs to be designed with special considerations to include negative balances in the sample d. the selection of zero balances usually does not requite special sample deign considerations when using monetary-unit sampling
an auditor needs to estimate the dollar amount of the standard deviation of the population in order to use classical variables sampling
Sales and accounts receivable
measured at the selling price
Revenue transaction controls: monthly customer statements mailed
occurrence, completeness, accuracy
Last receiving report number in 2018 was 49,745 12/30 49,742
okay because in December belong to the company
Auditor responsibilities (3rd principle)
3. competence and capabilities; compliance with ethical requirements; use professional skepticism and professional judgment throughout the planning and performance of the audit
Fraud
actions taken with the knowledge and intent to deceive
Strict privity (ultramares)
only 3rd parties NAMED in the contract
Securities Litigation Uniform Standards Act of 1998
-tries to prevent plaintiffs from filing suit in state courts as a means of evading/circumventing the federal statutes
Transaction-related assertions
-occurrence -completeness -VA-accuracy -VA-classification -VA-cutoff
AICPA (ASB)
-sets auditing standards for audits of non-public companies
Effect of the entity size
=the basic concepts of the five components should be present in all companies. They are likely to be less formal in a small or mid-size company than in a large company. -also keep in mind cost-benefit concerns
Which of the following is true of a SOC 2 engagement? a. the report resulting from a SOC 2 engagement can be made available for general use b. a SOC 2 engagement is based on criteria from COSO's internal control framework c. A SOC 2 engagement is based on Trust Services Criteria Security, Availability, Processing Integrity, Confidentiality, and Privacy d. The users of a SOC 2 report are not expected to understand to details of the IT system being reported on or the nature and limitations of a SOC 2 engagement
A SOC 2 engagement is based on Trust Services Criteria Security, Availability, Processing Integrity, Confidentiality, and Privacy
Audit committee
A committee consisting of members of the board of directors, charged with overseeing the entity's system of internal control over financial reporting, internal and external auditors, and the financial reporting process. Members typically must be independent of management.
Independence Rule (1.200)
A member in public practice must be independent when performing audits and other attest services (must be able to take an objective, unbiased view when rendering on opinion that others will rely on) -independent in mind (fact) --> in order to take an unbiased view -independent in appearance --> in order to maintain public confidence Rule only applies to "COVERED MEMBERS" - individual on the engagement team or who can influence it -partner or manager who provides> 10 hours non-attest services to the attest client -partner in the office where the lead engagement partner primarily practices -the firm as whole and its employee benefit plans
Acts Discreditable Rule (1.400, 2.400, 3.400)
A member shall not commit an act discreditable to the profession 1. employee discrimination and harassment 2. CPA exam question solicitation/disclosure 3. failure to file tax return 4. negligent preparation of financial statements or records 5. failure to follow rules of regulatory agencies or government bodies when performing services 6. including limitation of liability provisions in contracts when such provisions are prohibited 7. confidential information obtained from employment or volunteer activities 8. false, misleading, or deceptive acts in promoting or marketing professional services 9. use of CPA credential not in compliance with relevant state laws 10. failure to provide or return client records
Substantive procedures
Audit procedures performed to test material misstatements in an account balance or disclosure component of the financial statements.
Occurrence assertion: A sale is recorded for a shipment to a customer who did not place an order
Customer order number, if not then order should not be fulfill
Young and Younger, CPAs have been engaged to perform the audit of ABC Corp. The audit will be performed by the firm's Chicago office. For each of the following scenarios, determine whether the person in question qualifies as a "covered member." Jackie Olive, a tax staff accountant in the firm's Chicago office, spends approximately 30 hours annually on the preparation of the ABC's tax return.
No -non-attest service but not high enough level
True or false: the responsibility to assess the entity's ability to continue as a going concern rests with the auditor and the company's management
True
Young and Younger, CPAs have been engaged to perform the audit of ABC Corp. The audit will be performed by the firm's Chicago office. For each of the following scenarios, determine whether the person in question qualifies as a "covered member." Amy Wheat, a tax partner in the firm's New York Office, spends a significant amount of billable time reviewing ABC's tax return.
Yes -provides > 10 hours of non-attest services at partner level
Tolerable deviation rate
relationship to sample size: inverse
Overhead price test
review the client's method of overhead allocation for reasonableness, compliance with GAAP, and consistency
Going-concern considerations
to be a going concern is a good thing
Auditor's assessment of client's control is good and true state of the client's control is bad
worst place to be --> incorrect appearance
Which type of test and management assertion should be used for the following test: For a hotel client, use information about the year's average occupancy and average room rate to estimate revenue for the year. Compare to actual recorded revenue for reasonableness
type of test: substantive analytical procedures management assertion: accuracy
Types of services provided by accountants (non-assurance)
-tax prep and planning -management advisory/consulting -compilation
An audited company has not paid its 2018 audit fees. According to the AICPA Code of Professional Conduct, for the auditor to be considered independent with respect to the 2019 audit, the 2018 audit fees must be paid before the a. 2018 report is issued b. 2019 fieldwork is started c. 2019 report is issued d. 2020 fieldwork is started
2019 report is issued
Performance (4th, 5th, and 6th principles)
4. in order to express an opinion; must obtain reasonable assurance that F/S are free of material misstatement (whether error or fraud) 5. in order to obtain reasonable assurance, must plan and supervise; apply materiality; assess risk material misstatement based on an understanding of the entity and its internal control; obtain sufficient appropriate evidence 6. can not obtain absolute assurance because of inherent limitations of financial reporting, auditing and cost/benefit
An auditor desired to test credit approval on 10,000 sales invoices processed during the year. The auditor designed a statistical sample that would provide 1 percent risk of assessing control risk too low for the assertion that not more than 7 percent of the sales invoices lacked approval. The auditor estimated from previous experience that about 2½ percent of the sales invoices lacked approval. A sample of 200 invoices was examined, and 7 of them were lacking approval. The auditor then determined the computed upper deviation rate to be 8 percent. Based on the information above, the planned allowance for sampling risk was a. 5.5 percent b. 4.5 percent c. 3.5 percent d. 1 percent
4.5 percent
Unqualified/unmodified audit report
A "clean" audit report, indicating the auditor's opinion that a client's financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP).
The auditor is concerned that company personnel could inappropriately reduce customer account balances by recording a sales return, even though no product was actually returned Design a test of controls that tests the EXISTENCE/OCCURRENCE assertion for sales returns
Must need an authorization control that leave a trail- documentation when customer makes a return and person signs off (receiving document from customer) Start at sales return account --> authorization document Return authorization form for every returned item
In a jurisdiction that follows the restatement of Torts doctrine, which third parties have standing to sue an auditor for ordinary negligence?
NAMED third parties, parties whose reliance on the F/S was KNOWN by the auditor + parties whose reliance on the F/S was FORESEEN by the auditor
Near privity (credit alliance)
NAMES plus 3rd parties whose reliance on the financial statements was KNOWN
Auditor's assessment of client's control is bad and true state of the client's control is good
Not great place to be --> Incorrect rejection
Imprest account
a bank account containing a stipulated amount of money used for limited purposes (e.g. imprest accounts are frequently used for disbursing payroll and dividend checks)
Tech Company has appropriately disclosed an uncertainty due to pending litigation. However, the auditor was unable to satisfy herself that all pending litigation had been identified. The auditor's decision to issue a qualified opinion on Tech's financial statements would most likely result from a. a lack of sufficient evidence b. an inability to estimate the amount of loss c. the entity's lack of experience with such litigation d. a lack of insurance coverage for possible losses from such litigation
a lack of sufficient evidence
stand near the time clock and determine whether any employees punch in on more than one time card
evidence type: observation assertion: occurrence
Example of a commitment
long-term contracts to purchase raw materials or sell their products at a fixed price (1) to obtain a favorable pricing arrangement (2) to secure the availability of raw materials
Loss contingency: probable, not reasonably estimable
note disclosure only
used to obtain an understanding of the client's business
preliminary
Cash receipts from sales on account have been misappropriated. Which of the following acts would conceal this defalcation and be least likely to be detected by an auditor? a. understating the sales journal b. overstating the accounts receivable control account c. overstating the accounts receivable subsidiary ledger d. understating the cash receipts journal
understating the sales journal
King, CPA, was engaged to audit the financial statements of Chang Company, a private company, after its fiscal year had ended. King neither observed the inventory count nor confirmed the receivables by direct communication with debtors but was satisfied that both were fairly stated after applying appropriate alternative procedures. King's financial statement audit report most likely contained a(n) a. qualified opinion b. disclaimer of opinion c. unmodified opinion d. unmodified opinion with an emphasis-of-matter paragraph
unmodified opinion
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity's aging of receivables to support management's financial statement assertion of: a. existence b. valuation and allocation c. completeness d. rights and obligations
valuation and allocation
Rights and obligations
-assets are the rights of the entity and liabilities are the obligations of the entity
KPMG observes the weekly State Lottery Drawing for the purpose of verifying the integrity of the process used to draw the winning numbers each week. Their testing involves performing a list of verification procedures that have been agreed to by the Lottery Commission. KPMG issues a report that describes the procedures performed and a listing of their findings.
Attest (agreed upon procedures)
Monetary-unit sampling
Attribute-sampling techniques used to estimate the dollar amount of misstatement for a class of transactions or an account balance.
Type of reconciling item: errors
Bank to correct balance: bank error Book to correct balance: error made by company
Type of reconciling item: timing differences between bank recording the item and client books recording the item
Bank to correct balance: deposits in transit, outstanding checks Book to correct balance: bank service charges for the period posted by the bank, but not yet recorded by the company; interest earned for the person, not yet recorded by company
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. The company's management is responsible for maintaining effective internal control over financial reporting...
Basis for opinion
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. We conducted our audit in accordance with the standards of the public company accounting oversight board (US)
Basis for opinion
Electronic (Internet) commerce
Business transactions between individuals and organizations that occur without paper documents, using computers and telecommunication networks.
Electronic commerce
Business transactions between individuals and organizations that occur without paper documents, using computers and telecommunication networks.
Computer-assisted audit techniques (CAATs)
Computer programs that allow auditors to test computer files and databases.
For each misstatement which control activity, assertion, and suggested control are appropriate? The quantity of meat inventory purchased was significantly higher than the amount of product actually in the warehouse because employees in the warehouse receiving department diverted items for their personal use.
Control activity: Physical controls Assertion: Occurrence Suggested control: lock inventory/cameras swipe cards for access that track hours
For each misstatement which control activity, assertion, and suggested control are appropriate? An accounts payable clerk processed payments to himself by adding himself to the approved vendor master file.
Control activity: Segregation of duties Assertion: Occurrence/Authorization Suggested control: Password protection
A client fails to discover employee fraud on a timely basis because bank accounts are not reconciled monthly.
Control risk
For each item, indicate the section of the report where the information would appear, or if the information would not appear in the report. In our opinion, the financial statements reffered to above present fairly, in all material respects, the financial condition...
Does not appear in a separate report on ICFR
Analytical procedures
Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data.
Recorded cash disbursements are for goods and services that were actually purchased
Existence or occurrence
Is the auditor's opinion required to be in writing
Reporting -yes
Audit strategy
The auditor's plan for the expected conduct, organization, and staffing of the audit.
Confidence bound
a measure of sampling risk added and subtracted to the projected misstatement to form a confidence interval
Test of balances
a. tolerable misstatement b. expected misstatement c. projected misstatement d. upper misstatement limit
Loss contingency: probable and reasonably estimable
accrue loss *gain contingencies are not accrued and rarely even disclosed*
Revenue process: sale on account transaction
balance sheet: accounts receivable income statement: sales
Cash receipts controls: daily cash listing prepared; reconciled to A/R posting
completeness
Application controls
controls that apply to the processing of specific computer applications and art part of the computer programs used in the accounting system
Cash receipts controls: cash deposited daily; cash deposited intact
cut-off; completeness
Loss contingency: remote
disclosure not required
IR *CR of audit risk model
risk of material misstatement (RMM) -risk that material misstatement exist
CrFA- Certified Forensic Accountant
-American College of Forensic Examiners Institute (ACFEI)
Types of audit evidence commonly used in audit sampling
-Analytical procedures -Scanning -Inquiry -Observation
2. Tort Law Concepts
"reasonable" or "prudent" person standard -requires auditor to perform with due care -same degree of skill, knowledge, and judgment possessed by other members of the profession in a similar circumstance (reasonable auditor compared to this auditor discrepancies) -not a guarantee of perfection -liable for acts of negligence, bad faith, and dishonest, but not for pure errors of judgment (held responsible for)
Auditing the Tax Provision and Related Balance Sheet Accounts: The Basics
-GAAP accounting vs. Tax accounting -temporary differences -permanent differences
Inventory management for manufacturers
-assignment of direct and indirect labor costs -purchase of raw materials for production -payment of manufacturing overhead
Revenue transaction controls: approved price list
Authorization
VA-Cutoff assertion: a shipment received on October 25 is recorded as a November purchase
receiving reports forwarded to A/P department daily; purchases journal -> date of receiving report and terms of shipment
Observation
watching a process or procedure being performed by others
For the control activities to be effective, employees maintaining the accounts receivable ledger should not also approve a. employee overtime wages b. credit granted to customers c. write-offs of customer accounts. d. cash disbursements
write-offs of customer accounts
Despite performing an audit in conformity with GAAS, Able and Baker, CPAs issued an unqualified opinion on financial statements that contained a material misstatement
Audit risk
Revenue transaction controls: Open order file is reviewed
completeness
PCAOB
-sets auditing standards for audits of public companies
For effective internal control purposes, which of the following individuals should be responsible for mailing signed checks? a. receptionist b. treasurer c. accounts payable clerk d. payroll check
treasurer
Typical purchase transaction controls: pre-numbered purchase orders and receiving reports
completeness, existence
The AS contains guidance for performing substantive testing to respond to the risk of material misstatement in estimates, and it identifies three distinct approaches for auditing the client's estimates. What are the three approaches?
(1) Review and test the process used by management to develop the estimate (methods, data, assumptions, calculations, validity of management's estimates) (2) develop an independent expectation of the estimate to corroborate the reasonableness of management's estimate (3) review subsequent events or transactions occurring prior to the date of the auditor's report in post balance sheet period (to confirm or refute the adequacy of this year's estimate)
Benefits of bank-to-correct/Book-to-correct format
(1) it isolates the reconciling items that require adjustment on the client's books (2) it ultimately shows the "correct" cash balance on the face of the reconciliation
Types of reports on ICFR -qualified opinion
-ICFR is designed and operating effectively -only given if NO material weaknesses exist on the as of date NOTE: If a material weakness existed, but was remediated before the as of date and the audit was able to retest, then an unqualified opinion can be given
Necessary adjusting journal entries at 8/31 for sales related accounts
DR Sales CR AR
Gross negligence
all extreme, flagrant, or reckless departure from professional standards of due care
An assurance report on information can provide assurance about the information's a. reliability b. relevance c. timeliness d. all of the above
all of the above
Computer-assisted audit techniques (CAATs)
computer programs that allow auditors to test computer files and databases
Auditing Fair Value of Investments: Level 3
description: no active market; management judgment and assumptions used in valuation model valuation model: mark to model *often requires specialized knowledge
Overview of the purchasing process
purchase requisition purchase order receiving report (liability is recorded) vendor invoice received vendor check
Common test of details for accounts payable and other accounts: review voucher packets for documentation supporting that the liability pertains to this entity
rights and obligations
Working papers
the auditor's record of work performed and the conclusions reached on the audit
Dual dating
the auditor's report is dual dated when a subsequent event occurs after the date on which the auditor has obtained sufficient appropriate audit evidence but before the financial statements are issued
Which of the following best describes whether a CPA has met the required standard of care in auditing an entity's financial statements? a. whether the client's expectations are met with regard to the accuracy of audited financial statements b. whether the statements conform to generally accepted accounting principles c. whether the CPA conducted the audit with the same skill and care expected of an ordinarily prudent CPA under the circumstances d. whether the audit was conducted to investigate and discover all acts of fraud
whether the CPA conducted the audit with the same skill and care expected of an ordinarily prudent CPA under the circumstances
Jack Jackson is a CPA and the CFO of Acme Trucking. Acme's external auditors have asked Jack to sign the management representation letter. Jack signed it, even though he knows that some GAAP violations exist in the financial statements, and full disclosures of information have not been made to the auditors. 2.100
-Accounting Principles Rules under General Standards -->misrepresenting the financial statements conform with GAAP -Integrity and objectivity can have to do with misrepresentation of facts -->violation if he knowingly signs false representation letter
Assurance services is the broadest, most general category
-Independent professional services that improve the quality of information, or its context, for decision makers AICPA categories -risk assessment -business performance measurement -information system reliability -electronic commerce -healthcare performance measurement
Reports on comparative financial statements
-Issues that may arise: 1. change in the opinion on the prior year financials -Predecessor auditor issued the report on the previous year's financial statements 1. predecessor auditor re-issues its report 2. predecessor auditor does not re-issue its report -new auditor includes an explanatory paragraph that discusses the predecessor's opinion
Standard unqualified audit report for a public company (CAMS)
-Key content of the main body of the report 1.critical audit matters -definition of CAM -either state that there are none, or for each one identified, discuss (a) how identified (b) how addressed in the audit (c) identify accounts or disclosures related to the CAM -auditor information 1. firm's name (not the name of an individual partner) 2. tenure (we have served since X year) 3. specifies the city and state out of which the report was issued -date 1. NOT arbitrarily chose 2. corresponds to the last date of audit fieldwork 3. sets auditor's responsibility for knowledge of events impacting the financial statements through this date
A/R Confirmation Issues
-Must be controlled by the auditor (use client assistance) -confirmation control listing -paper vs. electronic (AR=paper, cash =electronic) (confirmation.come -> allow to answer many) -balance vs individual invoice -timing: interim vs year-ed -exceptions: actual misstatement, misunderstanding, timing difference (respond to wrong question or not answering question fully or correctly) -second requests and/or alternate procedures for unreturned positive confirmations (other evidence that customer did actually have balance --> paid off- subsequent realization, no payments -sales order and shipping information) -evaluate findings, and project to the population (recall sampling applications
The Entity's Risk Assessment Process
-Process for identifying and responding to business risks facing the entity -Principles include 1. clearly identifying objectives so that risks can be identified 2. identifying potential risks and how they should be managed 3. consideration of fraud potential 4. identification of changes that could impact internal control Examples of changes: a. new products/activities b. technology c. new accounting pronouncements
SEC Independence Rules
-Provision of non-audit services to audit clients The SEC's rules are predicted on three basic principles: 1. an auditor should not audit his or her own work 2. an auditor should not function in the role of management 3. an auditor should not serve in an advocacy role for his or her client
Emphasis paragraph (at the end of opinion section) [optional]
-Related party transactions -subsequent events -comparability matters (other than accounting changes) -uncertainty in future outcomes
Conceptual Framework Approach
-Rules and interpretations cover many situations, but are not exhaustive. For situations not explicitly covered, apply the conceptual framework 1. identify circumstances that would be threats to compliance 2. identify and apply safeguards (actions or measures that eliminate the threat or reduce it to an acceptable level) 3. In some cases, there is not way to reduce the threat to an acceptable level, so the member would be deemed to be in violation 4. if a member can not demonstrate that safeguards were applied that eliminated or reduced threats to an acceptable level, then the member is deemed to be in violation of the rule
common examples of accounting estimates
-allowance for uncollectible accounts receivable (don't know which customers won't pay and for how much -warranty liability revenue (don't know which products -will have warranty claims) -litigation contingencies (don't know if successful in litigation) -inventory obsolescence (unsaleable)
Audit field work for the audit of Utah Corp's December 31, 20X3 financial statements was completed on March 2, 20X4. Utah Corp. is a small public company. The auditors were not engaged to perform the audit until January 15, 20X4, and as a result, were not able to perform inventory observation or cut-off procedure at 12/31/X3. The auditors did extensive alternate testing, and were able to perform other procedures to satisfy themselves that the inventory and related balances are fairly stated. Inventory and related accounts are material to the financial statements of Utah Corp.
-Type of Audit opinion: standard unqualified opinion - additional paragraph content: none -paragraph location: none -paragraph heading: non -report date: March 2, 20X4
A final word of audit documentation
-even though the information in the work papers pertains to the client, the work papers are the property of the auditor -under the confidentiality rule of the code of professional conduct, there are limitations on the auditor's ability to share this information with 3rd parties -the Sarbanes-Oxley Act of 2002 (and PCAOB AS3) requires audit documentation to be retained for 7 years from the completion date of the engagement
CPA- Certified Public Accountant
-exam considered by AICPA -licensing government by state boards of accountancy
CIA- Certified Internal Auditor
-institute of internal auditors (IIA)
Standard unqualified audit report of a public company
-issued when the auditor has gathered sufficient evidence, the audit was performed in accordance with PCAOB standards, and the financial statements conform to GAAP
IAASB
-sets auditing standards that are globally available for adoption
FASB
-sets standards for the preparation of financial statements
Accounts payable confirmation
-used less than accounts receivable confirmation - not required by the auditing standards -the auditor is often able to examine externally created source documents relating to accounts payable -primary concern with payables is completeness. confirmation is better designed to test for existence
Monetary-Unit Sampling (MUS)
-uses attribute sampling theory, but expressed a conclusion in dollar amounts rather than an occurrence rate or deviation rate -estimates the percentage of the monetary units (dollars) in an account that might be misstated, and translates this into an estimate of the amount of misstatement in the overall account balance -commonly used to test A/R, loans receivable, investments, and inventory
Listing of Key Specific Rules
.100 Integrity and Objectivity: Integrity and Objectivity Rule .200 Independence: Independence Rules .300 General Standards: General Standards Rule, Compliance with Standards Rule, Accounting Principles Rule .400 Acts Discretible: Acts Discretible Rule .500 Fees: Contingent fee rule, Commissions and Referral Fees Rule .600 Advertising: Advertising and other forms of solicitation rule .700 Confidential information: confidential client information rule .800 Form of organization and name: form of organization and name rule
Audit report structure - public company with ICFR paragraph
1. Independent Registered Public Accounting Firm 2. The stockholders and Board of Directors of Bear Corp. 3. Opinion on the Consolidated Financial Statements 4. operations, stockholders' equity, and cash flows 5. notes 6. the "financial statements" 7. fairly, in all material respects 8. its operations and its cash flows 9. U.S. generally accepted accounting principles 10. the standards of the PCAOB 11. as of June 30, 20X3 12. the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 13. dated August 1, 20X3 14. an unqualified opinion 15. Basis for Opinion 16. the Company's management 17. express an opinion on the Company's financial statements based on our audits 18. the Public Company Accounting Oversight Board (United States) ("PCAOB") 19. independent 20. the Securities and Exchange Commission 21. the standards of the PCAOB 22. reasonable assurance 23. material misstatement 24. error or fraud 25. risks of material misstatement 26. error or fraud 27. evidence 28. significant estimates 29. evaluating the overall presentation of the financial statements 30. Auditor 31. How long they served as auditor 32. City 33. Date
Documenting the Auditor's Understanding of Internal Control
1. Procedure Manuals and Organizational Charts 2. Narrative Description 3. Internal Control Questionnaire 4. Flowcharts
Filling the assurance bucket
1. Risk assessment procedures 2. tests of controls 3. substantive analytical procedures 4. remaining assurance needed from tests of details
Types of audit tests: 3 categories
1. Risk assessment procedures/procedures to obtain an understanding -used to obtain an understanding of the entity and its environment, including internal controls 2. tests of controls -to evaluate the effectiveness of the design and implementation of internal controls 3. substantive procedures -to detect material misstatement in a transaction class, account balance, or disclosure component of the financial statements (substantive tests of transactions, tests of details of balances/disclosures, substantive analytical procedures)
Elements of a Separate Auditor's Report on ICFR
1. Title 2. Addressee 3. Opinion on Internal Control Over Financial Reporting: -identifies IC framework used -gives opinion -paragraph referencing report on the financial statements 4. Basis for Opinion -Management's responsibility and auditor's responsibility -standards of the PCAOB; reasonable assurance, materiality -brief description of the audit 5. Definition and Limitation of ICFR -Defines ICFR -Acknowledges inherent limitations of ICFR 6. Auditor signature/city/report date
Control 1: Risk of incorrect acceptance: 5% Tolerable deviation rate: 4% Expected population deviation rate: 1% Prescribed sample size: 158 Number of deviations found in testing: 0 Computed upper deviation rate: 1.90% Control 2: Risk of incorrect acceptance: 5% Tolerable deviation rate: 5% Expected population deviation rate: 2% Prescribed sample size: 184 Number of deviations found in testing: 5 Computed upper deviation rate: 5.72% Control 3: Risk of incorrect acceptance: 10% Tolerable deviation rate: 8% Expected population deviation rate: 4% Prescribed sample size: 100 Number of deviations found in testing: 4 Computed upper deviation rate: 8.00%
1. What interval would the auditor have used for selecting sample items, if the selection was one using a random start with a skip interval? -Control 1: 18.99 (3000/158) -Control 2: 16.30 (3000/184) -Control 3: 30 (3000/10) 2. What is the sample deviation rate -Control 1: 0% -Control 2: 2.72% (5/184) -Control 3: 4% (4/100) 3. Does the testing support the auditor's planned level of reliance on the control? Briefly explain how you came to each conclusion. -Control 1: CUDR = 1.90%, TDR = 4%, YES -Control 2: CUDR = 5.72%, TDR 5%, NO -Control 3: CUDR= 8%, TDR 8%, YES 4. How will these results affect the audit plan? -Control 1: Rely -Control 2: Don't rely -Control 3: Rely
2. Fraud
1. a false representation by the CPA 2. knowledge or belief by the CPA that the representation, was false 3. the CPA intended to include the party to rely on the false representation 4. the party relied on the false representation 5. the party suffered damages *reckless behavior by the auditors has been construed as fraud by some courts called gross negligence or constructive fraud*
An auditor performed a test of controls over credit approval using attribute sampling. A sample was designed that would provide 1% risk of assessing control risk too low. The auditor determined that as long as more than 7% of sales invoices lacked approval, the initial assessment of control risk would be supported. Based on prior experience, it is anticipated that 2.5% of sales invoices lacked approval. A sample of 200 invoices was examined, and 7 of them lacked approval. Based on these results, the auditor then determined (using statistical software) that the computed upper deviation rate was 8%. Determine the following values based on the above information.
1. desired confidence level: 99% 2. expected population deviation rate: 2.5% 3. tolerable deviation rate: 7% 4. sample deviation rate: 3.5% 5. allowance for sampling risk, based on these results: 4.5% 6. the auditor ultimately determined that it was necessary to increase his assessment of control risk based on these results. Why? --> CUDR> Tolerable
An auditor used attribute sampling to test a client control. Based on the auditor's initial assessment of control risk (moderate), the auditor plans to place moderate reliance on the control, and also perform a moderate amount of substantive testing of related accounts. The following information about sampling procedure is available: sample size: 50 deviations found: 3 tolerable deviation rate: 6% expected deviation rate: 4% allowance for sampling risk: 2.5%
1. sample deviation rate: 6% (3/50) 2. computed upper deviation rate: 8.5% 3. Based on the above, what conclusion should the auditor make about relying on the client's control and Why? --> They should not rely on controls CUDR > Tolerable 4. What impact will this have on the audit plan? --> Reevaluate: ineffective control should be considered and control deficiency unless entity remediates. Auditor must evaluate the likelihood and magnitude of potential misstatements arising from the control
James Elder, CPA is in the process of retiring and selling his public accounting practice. Joe Younger, CPA, a prospective buyer, wanted some insight into the clients in Elder's practice, so Elder allowed Younger to review some of his client work papers and files. Elder did not obtain permission from those clients, but he did receive assurance from Younger that the information would be kept confidential.
1.700 Confidential Client Information Rule Prospective buyers are allowed to have access to the client information as long as they are not sharing that information with others NOT a violation
Jack Black and Slim Jim recently received their CPA licenses, and have decided to open a public accounting practice together. They decided to call their practice "Arthur MacArthur and Co., CPAs' since the Arthur family has an excellent business and accounting reputation in town. However, none of the MacArthur actually have involvement with this firm.
1.800 Form of Organization and Name Rule Firm name cannot be misleading, use other name that is not involved VIOLATION
A plaintiff is suing an auditor for common law fraud in conducting a financial statement audit. What five elements must be proved by the plaintiff?
1.a false representation by the CPA 2. knowledge by the CPA that the statement was false 3. intent by the CPA to induce 3rd parties to rely on the false representation 4. plaintiff relied 5. plaintiff suffered damages
Representation letter
A letter that corroborates oral representations made to the auditor by management or by other auditors and documents the continued appropriateness of such representations.
Significant deficiency communication of internal control-related matters
A deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness but is important enough to merit attention by those charged with governance *must be communicated in writing to management and to those charged with governance
Material weakness
A deficiency, or combination of deficiencies, in internal control, such that there is a reasonable possibility that a material misstatement of the entity's financial statements will not be prevented, or detected and corrected, on a timely basis.
Misstatement
A departure from the applicable reporting framework (e.g. GAAP) that, if material, causes the financial statements to not be presented fairly. Misstatements may be classified as fraud (intentional), other illegal acts such as noncompliance with laws and regulations (intentional or unintentional), and errors (unintentional)
Misstatement
A difference between the amount, classification, presentation, or disclosure of a reported financial statement item and the amount, classification, presentation, or disclosure that is required for the item to be presented fairly in accordance with the applicable financial reporting framework.
Nonresponse
A failure of the confirming party to respond, or fully respond, to a positive confirmation request or a confirmation request returned undelivered.
Explanatory paragraph
A paragraph that is used under certain circumstances to provide additional explanation to users of the financial statements. Explanatory paragraphs do not affect the auditor's unqualified/unmodified opinion. Under GAAS, an explanatory paragraph that refers to a matter appropriately presented or disclosed in the financial statements is known as an emphasis-of-matter paragraph, while a paragraph that refers to matters other than those presented or disclosed in the financial statements is known as an other-matter paragraph.
Key position
A position in which an individual has (a) primary responsibility for significant accounting functions that support material components of the financial statements (b) primary responsibility for the preparation of the financial statements (c) the ability to exercise influence over the contents of the financial statements, including when the individual is a member of the board of directors, or similar governing body, chief executive officer, president, chief financial officer, chief operating officer, general counsel, chief accounting officer, controller, director of internal audit, director of financial reporting, treasurer, or any equivalent position.
Attest services
A service when a practitioner is engaged to issue or does issue a report on subject matter, or an assertion about subject matter, that is the responsibility of another party.
Code of Professional Conduct
A set of principles, rules, and interpretations that establish guidance for acceptable behavior for accountants and auditors.
Independence
A state of objectivity in fact and in appearance, including the absence of any significant conflicts of interest.
Control deficiency
A weakness in the design or operation of a control such that management or employees, in the normal course of performing their assigned functions, fail to prevent or detect misstatements on a timely basis.
Review of financial statements
An attest engagement designed to provide a moderate level of assurance through the performance of inquiry and analytical procedures providing the accountant a reasonable basis for expressing limited assurance that no material modifications should be made to the statements in order for them to conform to the applicable financial reporting framework.
Attest engagement
An engagement that requires independence as defined in AICPA Professional Standards. Attest engagements include financial statement audits, reviews, and examinations of prospective financial information.
PricewaterhouseCoopers completes an engagement and issues a report stating that no information came to their attention indicating that XYZ's financial statements are not fairly stated in conformity with U.S. Generally Accepted Accounting Principles.
Attest (review)
Monetary-unit sampling (MUS)
Attribute-sampling techniques used to estimate the dollar amount of misstatement for a class of transactions or an account balance.
Ernst & Young completes an engagement and issues a report stating that ABC Corp's financial statements conform with U.S. Generally Accepted Accounting Principles.
Audit
Other information
Audit evidence that includes minutes of meetings; confirmations from third parties; industry analysts' reports; comparable data about competitors (benchmarking); controls manuals; information obtained by the auditor from such audit procedures as inquiry, observation, and inspection; and other information developed by, or available to, the auditor that permits the auditor to reach conclusions through valid reasoning.
Tests of controls
Audit procedures performed to test the operating effectiveness of controls in preventing, or detecting and correcting, material misstatements at the relevant assertion level.
Non-statistical sampling
Audit sampling that relies on the auditor's judgement to determine the sample size, select the sample, and/ or evaluate the results for the purpose of reaching a conclusion about the population.
What qualifications or skills is an auditor expected to possess or exercise?
Auditor's responsibilities -competence and capabilities -professional judgment and professional skepticism
What things is management responsible for providing to the auditor?
Purpose and premise, principle 2 -preparing financial statements and maintain IC and provide auditor with information
Recap of AICPA Key Independence Concepts
CPA COVERED MEMBER -PROHIBITED direct financial interest -OK unless material to person's wealth for indirect financial interest -PROHIBITED with key position with auditee (subsequent employment OK if certain conditions met) IMMEDIATE FAMILY -PROHIBITED direct financial interest -OK unless material to person's wealth for indirect financial interest -PROHIBITED with key position with auditee CLOSE RELATIVE -OK unless material to person's wealth for direct financial interest - OK unless material to person's wealth for indirect financial interest - PROHIBITED with key position with auditee
Blue and Gold, CPAs provide a variety of tax and assurance services. Blue and Gold have a commission agreement with CompuTech, a software company. Under this agreement, CompuTech will pay Blue and Gold a commission equal to 10% of the revenue they generate from making software sales to customers who were referred to Blue and Gold. a. Sam Smith, one of Blue and Gold's tax clients, needs some software, and asks Blue and Gold to make a recommendation. Blue and Gold recommend a CompuTech product and disclose the commission arrangement. Blue and Gold collect a commission from CompuTech on this sale. b. Bob Baker, one of Blue and Gold's audit clients, needs some software, and asks Blue and Gold to make a recommendation. Blue and Gold recommend a CompuTech product, and disclose the commission arrangement. Blue and Gold collect a commission from CompuTech on this sale.
Commissions and referrals fee rule --> commission only allowed for non-attest clients. OK if non-attest and disclosed = NOT a violation Violation because its an attest client **they can make recommendation just not get paid for it**
Two classes of law
Common law: case law developed by judges Statutory law: written law enacted by the legislative branch of government
Revenue: design a test of controls that tests the COMPLETENESS assertion for cash receipts
Control that should be in place: a daily cash listing is prepared, and is reconciled to daily postings to accounts receivable. Test by reviewing a sample of daily cash listings and reconciliations to accounts receivable postings Control that should be in place: preparation of monthly bank reconciliations. Test by reviewing a sample of monthly bank reconciliations prepared during the year. Test details of 12/31 cash reconciliation
General controls
Controls that relate to the overall information processing environment and have a pervasive effect on the entity's computer operations.
Auditor's assessment of client's controls is good and true state of the client's control is good
Correct decision
In your audit of Appleton Industries for 20X1, you found a number of matters that you believe represent necessary adjustments to the company's books in order to comply with GAAP. Planning materiality for the engagement was initially $75,000 (which was based on 5% of expected income before taxes, calculated at the time of planning). Actual 20X1 income before taxes (prior to any adjustments) is $1,200,867. During the testing of Appleton's depreciation schedules, you noted that the annual depreciation on the company's leasehold improvements was correctly calculated as $10,500. However, you noted that the journal entry recording this depreciation was recorded twice. *double booked entry
DR Accumulated Depreciation CR Depreciation Expense Adjustment dollar amount: $10,500 Effect on total assets: decrease of $10,500 Effect on total liabilities: N/A Effect on S/E: N/A Effect on total revenue: N/A Effect on total expenses: decrease of $10,500 Effect on net income: increase of $10,500
Clarification on mutual funds
Example: ABC diversified mutual fund contains shares of coca-cola stock Abe accountant owns shares of ABC -this is a direct interest in ABC diversified mutual -this is an indirect interest in coca-cola -If Abe is a covered member with respect to ABC, he is not allowed to own any shares of ABC -If Abe is a covered member with respect to Coca-cola (he owns 5% or less of ABC, this will not be considered a material interest in Coca-cola, so will be allowed) (If he owns > 5% of ABC, or if ABC is not diversified, he will have to evaluate the materiality of the Coca-cola portion in comparison to his own wealth
Example of substantive procedures: tests of transactions
For a sample of 50 checks, verify that the amount of the cancelled check agrees to the amount of the vendor invoice, the amount of the purchase order, and the amount recorded in the CD journal
Material misstatement of a 12/31 account balance is detected by auditor in January. Company refuses to adjust financial statements
Impact on ICFR audit: Adverse opinion Impact on F/S audit: Adverse opinion
Material misstatement of a 12/31 account balance is detected by auditor in January. Company agrees to adjust financial statements.
Impact on ICFR audit: Adverse opinion Impact on F/S audit: Unqualified opinion
Material weakness in a control is detected in December and not remediated until January
Impact on ICFR audit: Adverse opinion Impact on F/S audit: Shift to substantive strategy for accounts affected
Material weakness in a control is detected in August. Company remediates and auditor retests before 12/31
Impact on ICFR audit: Unqualified opinion Impact on F/S audit: Shift to substantive strategy for accounts affected
Which of the following best places the events on the last decade in proper sequence? a. Sarbanes-Oxley Act, increased consulting services to auditees, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB b. increased consulting services to auditees, Sarbanes-Oxley Act, Enron and other scandals, prohibition of most consulting work for auditees, establishment of PCAOB c. Enron and other scandals, Sarbanes-Oxley Act, increased consulting services to auditees, prohibition of most consulting work for auditees, establishment of PCAOB. d. Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB
Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB
What is the name of the auditing standards promulgated by the IAASB?
International Standards of Auditing
Types of fraud
Misappropriation of assets (theft) -may result in misstatements, but that is not the primary motivation -e.g., embezzlement, theft of other assets, over payment & kick-back schemes with 3rd parties Fraudulent Financial Reporting -intentional misstatement or omission of amounts or disclosures with the intent to deceive users -may involve overstatement, understatement, income smoothing -can involve altering records and documents, omission of information, misapplication of accounting principles
Last receiving report number in 2018 was 49,745 1/02 49,743
Not okay because smaller than 49,745 DR Supplies 42,000 CR Accounts Payable 42,000
Revenue transaction controls: Approved customer order initiates shipping request; invoice generation and sales journal entry require valid customer order number and shipper number; shipper number can not be used for multiple invoices
Occurrence, accuracy
Financial statements are NOT fairly stated, and the misstatements are covering an underlying problem with the client's financial health. Auditor issues an unqualified opinion on the financial statements. Client business fails the following year
Opinion was not appropriate. Auditor's liability depends on the quality of the audit work. If the auditor used due care and complied with GAAS/PCAOB standards --> NOT liable. This is an example of audit risk rearing its ugly head. If the auditor did not use due care and failed to comply with GAAS/PCAOB standards --> Auditor is liable
"Fraud" or "error" mentioned
PCAOB report guidance: basis for opinion section AICPA report guidance: management's responsibility section, auditor's responsibility section
The notes to the financial statements contain information required by GAAP about long-term debt maturities and interest rates
Presentation and disclosure
Occurrence assertion: A sale is recorded, even though the goods ordered were not shipped
Sale recorded and receive message to be okay to record sale. Match shipping document with invoices (sales journal) -item actually sent
Agreed-upon procedures
Specific procedures performed on the subject matter of an assertion while a practitioner is engaged by a client to issue a report of findings.
Test of details of account balances and disclosures
Substantive tests that concentrate on the details of items contained in the account balance and disclosure identify the primary source of information for the balance in question examine evidence that supports (or refutes) the legitimacy of the balance
Tests of details
Substantive tests that concentrate on the details of items contained in the account balance and disclosure.
Principles Underlying an Audit Performed in Accordance with GAAS
The ASB replaced the 10 generally accepted auditing standards with these principles, organized in four parts: purpose of an audit and premise upon which an audit is conducted, auditor responsibilities, audit performance, and audit reporting
Which of the following statements concerning monetary-unit sampling is correct? a. the sampling distribution should approximate the normal distribution b. overstated units have a lower probability of sample selection than units that are understated c. the auditor controls the risk of incorrect acceptance by specifying the desired confidence level for the sampling plan d. the sampling interval is calculated by dividing the number of physical units in the population by the same size
The auditor controls the risk of incorrect acceptance by specifying the desired confidence level for the sampling plan
Reliance strategy breakdown
The auditor obtains understanding of internal control -IF controls are preliminary assessed as effective and testing the effectiveness of controls is deemed to be efficient the auditor may asses control risk below maximum and plan to rely on internal control MUST TEST CONTROLS -reliance is allowed only if testing supports planned level of reliance **RELY on controls**
Recalculation
The auditor's checking the mathematical accuracy of documents or records either manually or electronically.
Qualified opinion
The auditor's opinion that the financial statements present fairly, in all material respects, in accordance with generally accepted accounting principles (or other basis of accounting), except for a material misstatement that does not, however, pervasively affect users' ability to rely on the financial statements. Can also be issued for a scope limitation that is of limited significance.
Unqualified/Unmodified opinion
The auditor's opinion that the financial statements present fairly, in all material respects, the client's financial position, results of operations, and cash flows in accordance with generally accepted accounting principles (or other basis of accounting)—i.e., a "clean" opinion.
Information asymmetry
The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does.
Materiality
The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users.
Overall materiality (planning materiality)
The maximum amount by which the auditor believes the financial statements could be misstated and still not affect the decisions of users.
Tolerable deviation rate
The maximum deviation rate from a prescribed control that the auditor is willing to accept without altering the planned assessed level of control risk.
Internal control
The method by which an entity's board of directors, management, and other personnel provide reasonable assurance about the achievement of objectives in the following categories: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with applicable laws and regulations.
Period of the professional engagement
The period for which a member either signs an initial engagement letter or other agreement to perform attest services or begins to perform an attest engagement for an entity, whichever is earlier. The period lasts for the entire duration of the professional relationship and ends with the formal or informal notification, either by the member or the entity, of the termination of the professional relationship or by the issuance of a report, whichever is later. Accordingly, the period does not end with the issuance of a report and recommence with the beginning of the following year's attest engagement.
Remediation
The process of correcting a material weakness as part of management's assessment of the effectiveness of ICFR
Relevance of evidence
The relevance of audit evidence refers to its relationship to the assertion or to the objective of the control being tested.
Inherent risk
The susceptibility of an assertion about a class of transaction, account balance, or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.
Factual misstatements
These are misstatements about which there is no doubt. For example, an auditor may test a sales invoice and determine that the prices applied to the products ordered are incorrect. Once the products are correctly priced, the amount of misstatement is known. In such cases, the auditor knows the exact amount of the misstatement.
Zebra Corp has 1,000 hula hoops that are being held on consignment by Lion Corp. Zebra includes these hula hoops in its inventory account. Which of the following statements regarding Zebra is true. a. This treatment is proper b. This treatment violates the existence assertion c. This treatment violates the accuracy assertion d. This treatment violates the rights and obligations assertion
This treatment is proper
Safeguarding of assets
Those policies and procedures that provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the entity's assets that could have a material effect on the financial statements.
Conditions indicative of fraud and fraud risk factors
Three conditions usually exist when fraud occurs 1. Incentive or pressure: to perpetrate fraud 2. Opportunity: to carry out the fraud 3. Attitude or rationalization: to justify fraud
A walkthrough is one procedure used by an auditor as part of the internal control audit. A walkthrough requires an auditor to a. tour the organization's facilities and locations before beginning any audit work b. trace a transaction from every class of transactions from origination through the entity's information system c.trade a transaction from each major class of transaction from origination through the entity's information system d. Trace a transaction from each major class of transactions from origination through the entity's information system until it is reflected in the entity's financial reports
Trace a transaction from each major class of transactions from origination through the entity's information system until it is reflected in the entity's financial reports
Typical purchase transaction controls: accounts payable subsidiary ledger reconciled to general ledger account balance
VA- accuracy (tie-in)
Revenue transaction controls: credit approval of customer order required before order fulfillment
VA-Accuracy/Authorization
Test of details for AR and related accounts: Allowance for uncollectible A/R; Test aging report and historical bad debt %; Lookback at adequacy of prior year estimate vs actual write-offs; Lookback at adequacy of current year estimate vs collections during the post-balance sheet period
VA-Realizable value
The balance in the Accounts Payable general ledger account agrees to the balance supported by the detailed A/P subsidiary ledger
Valuation or allocation -Accuracy --> tie-in
Rick, an independent CPA, must make an ethical judgment related to the audit of an entity. If he primarily focuses on whether his decision might yield unfair advantages for some of the expense of others, he is using a. a utilitarian perspective b. a rights-based approach c. a justice-based perspective d. rule-based AICPA guidelines
a justice-based perspective
Class action
a lawsuit filed by one or more individuals on behalf of all persons who may have invested on the basis of the same false and misleading information
Representation letter
a letter that corroborates oral representations made to the auditor by management or by other auditors and documents that contained appropriateness of such representations
Purchasing process
a purchase transaction usually begins with a purchase requisition generated by the user department. The purchasing department prepares a purchase order that is sent to the vendor. When the goods are received or the services rendered, a liability is recorded. Finally, the entity pays the vendor
Eagle Company, a public company, had a computer failure and lost part of its financial data. As a result, the auditor was unable to obtain sufficient audit evidence relating to Eagle's inventory account. Assuming the inventory account is at least material, the auditor would most likely choose either a. a qualified opinion or a disclaimer of opinion b. a qualified opinion or an adverse opinion c. an unqualified opinion with no explanatory paragraph for an unqualified opinion with an explanatory paragraph d. a qualified opinion with no explanatory paragraph or a qualified opinion with an explanatory paragraph
a qualified opinion or a disclaimer of opinion
When assessing the tolerable deviation rate, the auditor should consider that, while deviations from control procedures increase the risk of material misstatements, such deviations do not necessarily result in misstatements. This explains why a. a recorded disbursement that does not show evidence of required approval may nevertheless be a transaction that is properly authorized and recorded b. deviations would result in errors in the accounting records only if the deviations and the misstatements occurred on different transactions c. deviations from pertinent control procedures at a given rate ordinarily would be expected to result in misstatements at a higher rate d. a recorded disbursement that is properly authorized may nevertheless be a transaction that contains a material misstatement
a recorded disbursement that is properly authorized may nevertheless be a transaction that contains a material misstatement
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
Exception
a response that indicates a difference between information requested to be confirmed, or contained in the entity's records, and information provided by the confirming party
Covered member. A member that is
a. an individual on the attest engagement team b. an individual in a position to influence the attest engagement c. a partner or manager who provides non attest services to the attest entity beginning once he or she provides 10 hours of non attest services to the entity within any fiscal year and ending on the later of the data (i) the firm signs the report on the financial statements for the fiscal year during which those services were provided, or (ii) he or she no longer expects to provide 10 or more hours of non attest services to the attest entity on a recurring basis d. a partner in the office in which the lead attest engagement primarily practices in connection with the attest engagement e. the firm, including the firm's employee benefit plan f. an entity whose operating, financial, or accounting policies can be controlled (as defined by the generally accepted accounting principles for consolidation purposes) by any of the individuals or entities describes in parts (a) through (e), or by two or more such individuals or entities if they act together
Which of the following matters should an auditor communicate to those charged with governance? Significant audit adjustments, management's consultations with other accountants a. yes, yes b. yes, no c. no, yes d. no, no
a. yes, yes
side agreements
ability of customer to change their mind and return items if necessary
Specific audit procedures conducted near completion of audit: inquiry and discussion with management
about the policies and procedures for identifying, evaluating, and accounting for contingent liabilities
Events of the past 2 decades have shaped the accounting profession
accounting scandals -called the auditor's performance into question -highlighted independence issues related to fees for performing consulting work government regulation to restore public confidence -Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002 (SOX) -Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank)
Revenue process: Balance sheet: Common Analytical procedures
accounts receivable turnover aging categories on aged trial balance of A/R allowance for uncollectible accounts as a percent of A/R
Typical purchase transaction controls: math accuracy of vendor invoices verified before processing
accuracy
Typical purchase transaction controls: purchase orders contains sufficient detail; purchase order agreed to receiving report and vendor invoices
accuracy
Typical purchase transaction controls: daily purchases journal totals reconciled to daily postings in accounts payable
accuracy (posting)
Cash receipts controls: daily cash reconciled to postings to cash receipts journal and A/R subsidiary ledger
accuracy; classification
Financial statements that have been reviewed by an accountant should be accompanied by a report stating that a. the scope of the inquiry and the analytical procedures performed by the accountant have not been restricted b. all information included in the financial statements in the representation of the management of the entity c. a review includes examining on a test basis, evidence supporting the amounts and disclosures in the financial statements d. a review is greater in scope than a compilation, the objective of which is to express an affirmative opinion on the financial statements are free of material misstatements
all information included in the financial statements in the representation of the management of the entity
Preliminary engagement activities include a. understanding the client and the client industry's b. determining audit engagement team requirements c. ensuring the independence of the audit team and audit firm d. all of the above
all of the above
Internal control is a process designed to provide reasonable assurance regarding the achievement of which objective? a. effectiveness and efficiency of operations b. reliability of financial reporting c. compliance with applicable laws and regulations d. all the above are correct
all of the above are correct
The engagement partner and manager review the work of engagement team members to evaluate which of the following> a. the work was performed and documented b. the objectives of the procedures were achieved c. the results of the work support the conclusions reached d. all of the above are correct
all of the above are correct
Examination engagement
an attest engagement designed to provide a high level of assurance through the performance of a full set of procedures similar to those used in an audit, providing the accountant a reasonable basis for expressing an affirmative opinion that the subject matter is fairly stated in conformity with a set of criteria
Which of these statements concerning illegal acts by clients is correct? a. an auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud b. an audit in accordance with auditing standards normally includes audit procedures specifically designed to detect illegal acts that have an indirect but material effect on the financial statements c. an auditor considers illegal acts from the perspective of the reliability of management's representations rather than their relation to audit objectives derived from financial statement assertions d. an auditor has no responsibility to detect illegal acts by the clients that have an indirect effect on the financial statements
an auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud
Which of the following is a misappropriation of assets? a. classifying inventory held for resale as supplies b. investing cash and earning at a 3 percent rate of return as opposed to paying off a loan with an interest rate of 7 percent c. an employee of a consumer electronics store steals 12 CD players d. management estimates bad debt expense as 2 percent of sales when it actually expects bad debts equal to 10 percent of sales
an employee of a consumer electronics store steals 12 CD players
Which of the following professional services would be considered an attest engagement? a. a management consulting engagement to provide IT advice to a client b. an engagement to report on compliance with statutory requirements c. an income tax engagement to prepare federal and state tax returns d. preparation of financial statements from a client's accounting records
an engagement to report on compliance with statutory requirements
SOC 1, Type 2 reports issues by the service organization's auditor typically a. provide reasonable assurance that their financial statements are free of material misstatements b. ensure that the entity will not have any misstatements in areas related to the service organization's activities c. ensure that the entity is billed correctly d. assess whether the service organization's controls are suitably designed an operating effectively
assess whether the service organization's controls are suitably designed an operating effectively
The primary objective of final analytical procedures is to a. obtain evidence from details tested to corroborate particular assertions b. identify areas that represent specific risks relevant to the audit c. assist the auditor in assessing the validity of the conclusions reached on the audit d. satisfy doubts when questions arise about an entity's ability to continue in existence
assist the auditor in assessing the validity of the conclusions reached on the audit
Precision
at the planning stage of the audit, sampling is the difference between the expected and tolerable error tighter precision requires a bigger sample -expected error requires bigger sample -tolerable error require bigger sample
Typical cash disbursement controls: checks prepared only after approved supporting documentation is collected (3 way match of purchase order, receiving report, vendor invoice)
authorization; VA-Accuracy
Revenue Process: Uncollectibility Allowance (Provision)
balance sheet: allowance for doubtful accounts income statement: bad debt expense
Revenue process: Collection of accounts receivable
balance sheet: cash, accounts receivable income statement: N/A
After obtaining an understanding of entity's internal control system, an auditor may set control risk as high for some assertions because the auditor a. believes the internal controls are unlikely to be effective b. determines that the pertinent internal control components are not well documented c. performs tests of controls to restrict detection risk to an acceptable level d. identifies internal controls that are likely to prevent material misstatement
believes the internal controls are unlikely to be effective
interbank transfer schedule #2 amount, recorded in client books, paid by bank (disbursements); recorded in clients books, received by bank (receipts) $10,000 1/2,1/2;12/30,12/31
both sets of books claim to own this cash on 12/31 so --> KITING
Revenue transaction controls: Pre-numbered documents (shippers, invoices)
completeness (and occurrence)
VA-Classification assertion: a receipt of items in the "sporting goods" product line is recorded as a receipt of "toys"
chart of accounts, review drafts of financial statements, presentation, disclosures
confirmation of receivables by an auditor fails to detect a material misstatement
detection risk
Communications with Audit Committee (REQUIRED)
communications related to the financial statement audit -significant accounting policies -critical estimates and unusual transactions -significant audit adjustments; unadjusted differences -management judgments -disagreements with management communications related to the ICFR audit -all significant deficiencies and material weaknesses (to the audit committee and management) -all control deficiencies (to management and notify the audit committee)
Channel stuffing
company is trying to increase their sales for this period by buying more than necessary units. this create a temporary shift in revenue for this year and lowers revenue for next year
Cash receipts controls: monthly customer statements mailed
completeness
An auditor testing long-term investments would ordinarily use substantive analytical procedures to ascertain the reasonableness of the a. existence of unrealized gains or losses in the portfolio b. completeness of recorded investment income c. classification between current and non-current portfolios d. valuation of marketable equity securities
completeness of recorded investment income
An auditor desired to test credit approval on 10,000 sales invoices processed during the year. The auditor designed a statistical sample that would provide 1 percent risk of assessing control risk too low for the assertion that not more than 7 percent of the sales invoices lacked approval. The auditor estimated from previous experience that about 2½ percent of the sales invoices lacked approval. A sample of 200 invoices was examined, and 7 of them were lacking approval. The auditor then determined the computed upper deviation rate to be 8 percent. In the evaluation of this sample, the auditor decided to increase the level of the preliminary assessment of control risk because the a. tolerable deviation rate (7 percent) was less than the computed upper deviate rate (8 percent) b. expected population deviate rate (7 percent) was more than the percentage of errors int he sample (3.5 percent) c. computed upper deviation rate (8 percent) was more than the percentage of errors in the sample (3.5 percent) d. Expected population deviation rate (2.5 percent) was less than the tolerable deviation rate (7 percent)
computed upper deviation rate (8 percent) was more than the percentage of errors in the sample (3.5 percent)
Assessing control risk below high involves all of the following except a. identifying specific controls to rely on b. concluding that controls are ineffective c. performing tests of controls d. analyzing the achieved level of control risk after performing tests of controls
concluding the controls are ineffective
Confidence level --> level of uncertainty that your conclusion is correct
confidence level is the complement of sampling risk sampling risk=5% THEN confidence level = 95%
DR of audit risk model
detection risk -risk that the auditor will fail to detect misstatements that exist
Which of the following best describes the general chapter of the section of the "Principles Underlying an Audit of Financial Statements," titled "Performance"? a. description of competence, independence, and professional care of persons performing the audit b. criteria for the content of the auditor's report on financial statements and related footnote disclosures c. criteria for audit planning and evidence gathering d. the need to maintain an independence of mental attitude in all matters relating to the audit
criteria for audit planning and evidence gathering
The objectives of internal control for an inventory management process are to provide assurance that transactions are properly authorized and record and that a. independent internal verification of activity reports is established b. transfers to the finished goods department are documented by a completed production report and a quality control report c. production orders are prenumbered and signed by a supervisor d. custody of work in process and finished goods is properly maintained
custody of work in process and finished goods is properly maintained
Key segregation of duties (CAR)
custody, authorization, recording
Revenue process: Typical documents and records in the sales process
customer sales order credit approval form open-order report shipping document sales invoice sales journal (DR a/r CR sales) customer statement A/R subsidiary ledger Aged trial balance of A/R Cash receipts journal Remittance Advice Credit Memo Write-off Authorization
A control deviation caused by an employee performing a control procedure that he or she is not authorized to perform is always considered a a. deficiency in design b. deficiency in operation c. significant deficiency d. material weakness
deficiency in operation
Under the Private Securities Litigation Reform Act, Baker, CPA, reported certain uncorrected illegal acts to Supermart's board of directors. Baker believed that failure to take remedial action would warrant a qualified audit opinion because the illegal acts had a material effect on Supermart's financial statements. Supermart failed to take appropriate remedial action, and the board of directors, refused to inform the SEC that is had received such notification from Baker. Under these circumstances, Baker is required to a. resign from the audit engagement within 10 business days b. deliver a report concerning the illegal acts to the SEC within one business day c. notify the stockholders that the financial statements are materially misstated d. withhold an audit opinion until Supermart takes appropriate remedial action
deliver a report concerning the illegal acts to the SEC within one business day
When planning an audit, an auditor should a. consider whether the extent of substantive procedures may be reduced based on the result of tests of controls b. determine overall materiality for audit purposes c. conclude whether changes in compliance with prescribed internal controls justify reliance on them d. evaluate detected misstatements
determine overall materiality for audit purposes
Smith Corporation has numerous customers. A customer file is maintained and includes a customer record with a name, an address, a credit limit, and an account balance. The auditor wishes to test this file to determine whether credit limits are being exceeded. The best procedure for the auditor to follow would be to a. develop test data that would cause some account balances to exceed the credit limit and determine if the system properly detects such situations b. develop a program to compare credit limits with account balances and print out the details of any account with a balance exceeding its credit limit c. request a printout of all account balances so that they can be manually checked against the credit limits d. request a printout of a sample of account balances so that they can be individually check against the respective credit limits
develop a program to compare credit limits with account balances and print out the details of any account with a balance exceeding its credit limit
Which of the following best describes the reason why an independent auditor is often retained to report on financial statements? a. management fraud may exist, and it is more likely to be detected by independent auditors than by internal auditors b. different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements c. a misstatement of account balances may exist, and all misstatements are generally corrected as a result of the independent auditor's work d. an entity may have a poorly designed internal control system
different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements
Which of the following audit procedures would probably provide the most reliable evidence concerning the entity's assertion of rights and obligations related to inventory? a. tracing of test counts noted during the entity's physical count to the entity's summarization of quantities b. inquiry of management to determine whether there are significant purchase commitments that should be considered for disclosure c. selection of the law few shipping advices used before the physical count and determination of whether the shipments were recorded as sales d. during physical observation of inventory verify that "bill-and-hold" inventory is segregated and not included in the ending inventory count
during physical observation of inventory verify that "bill-and-hold" inventory is segregated and not included in the ending inventory count
An auditor would probably be least interested in which of the following fields in an electronic perpetual inventory file? a. economic reorder quantity b. warehouse location c. date of last purchase d. quantity sold
economic reorder quantity
The risk of incorrect acceptance relates to the a. effectiveness of the audit b. efficiency of the audit c. planning materiality d. allowable risk of tolerable misstatement
effectiveness of the audit
Operational auditing is oriented primarily toward a. efficiency and future improvements to accomplish the goals of management b. the accuracy of data reflected in management's financial records c. verification that an entity's financial statements are fairly presented d. past protection provided by existing internal control
efficiency and future improvements to accomplish the goals of management
Which of the following is a provision of the Foreign Corrupt Practices Act? a. it is a criminal offense for an auditor to fail to detect and report a bribe paid by an American business entity to a foreign official for the purpose of obtaining business b. the auditor's detection of illegal acts committed by officials of the auditor's publicly held client in conjunction with foreign officials should be reported to the Enforcement Division of the Securities and Exchange Commission c. If the auditor of a publicly held company concludes that the effects on the financial statements of a bribe given to a foreign official re not reasonable estimated, the auditor's report should be modified d. every publicly held company must devise, document, and maintain a system of internal accounting controls sufficient to provide reasonable assurance that internal control objectives are met
every publicly held company must devise, document, and maintain a system of internal accounting controls sufficient to provide reasonable assurance that internal control objectives are met
review the client's file of check disbursements made during the first four weeks of January, and determine that expenditures for December purchases were appropriately accrued as payables as of 12/31
evidence type: inspection of documents and records assertion: existence (completeness)
test foot the client's fixed asset ledger and determine that the total agrees to the general ledger
evidence type: recalculation assertion: valuation/allocation-accuracy
Jenna Corporation approved a merger plan with Cord Corporation. One of the determining factors in approving the merger was the financial statements of Cord, which had been audited by Frank & Company, CPAs. Jenna had engaged Frank to audit Cord's financial statements. While performing the audit, Frank failed to discover fraud that later caused Jenna to suffer substantial losses. For Frank to be liable under common-law negligence, Jenna at a minimum must prove that Frank: a. knew of the fraud b. failed to exercise due care c. was grossly negligent d. acted with scienter
failed to exercise due care
Which of the following is correct concerning required auditor communications about fraud? a. fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved b. fraud with a material effect on the financial statements should be reported directly by the auditor to Securities and Exchange Commission c. any requirement to disclose fraud outside the entity is the responsibility of management and not that of the auditor d. the professional standards provide no requirements related to the communication of fraud, but the auditor should use professional judgment in determining communication responsibilities
fraud that involves senior management should be reported directly by the auditor to the audit committee regardless of the amount involved
Labor price test
gather evidence about the type and amount of labor needed for production and the labor rate
UML > TOLERABLE
high probability that balance is materially misstated may need to perform additional substantive procedures to substantiate amount of misstatement discuss adjustment with client possibility of adverse or qualified opinion
Purchase cutoff activities should be designed to test that merchandise is included in the inventory of the company if the company: a. holds the shipping documents for the merchandise issued in the company's name b. holds legal title to the merchandise c. has physical possession of the merchandise d. has paid for the merchandise
holds legal title of the merchandise
Substantive analytical procedures
identify key financial and nonfinancial information that you could use to help "estimate" what the balance should be
During the initial planning phase of an audit, a CPA most likely would a. identify specific internal control activities that are likely to prevent fraud b. evaluate the reasonableness of the entity's accounting estimates c. discuss the timing of the audit procedures with the entity's management d. inquire of the entity's attorney if it is probable that any unrecorded claims will be asserted
identify specific internal control activities that are likely to prevent fraud
Tests of transactions
identify the population from which you will select your sample, and the supporting evidence you will look at keep in mind the direction of the test
Types of reports on ICFR -disclaimer
if there was a serious cope limitation
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance Identifies "error" and "fraud" as two possible causes of material misstatement
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "in our opinion, the financial statements present accurately the financial position of Ace Corp. as of December 31"
in neither a report preprated under the PCAOB reporting guidance nor a report prepared under AICPA reporting guidance
When is a duty to disclose fraud to parties other than the entity's senior management and its audit committee most likely to exist? a. when the amount is material b. when the fraud results from misappropriation of assets rather than fraudulent financial reporting c. in response to inquiries from a successor auditor d. when a line manager rather than a lower-level employee commits the fraudulent act
in response to inquiries from a successor auditor
How would increases in tolerable misstatement and assessed level of control risk affect the sample size in a substantive test of details? Increase in tolerable misstatement, Increase in Assessed Level of Control Risk a. decrease sample size, decrease sample size b. decrease sample size, increase sample size c. increase sample size, decrease sample size d. increase sample size, increase sample size
increase sample size, decrease sample size
Comparative financial statements for a public company include the prior year's statements, which were audited by a predecessor auditor. The predecessor's report is not presented along with the comparative financial statements. If the predecessor's report was unqualified, the successor should a. express an opinion on the current year's statements alone and make no reference to the prior year's statements b. indicate in the auditor's report that the predecessor auditor expressed an unqualified opinion c. obtain a letter of representations from the predecessor concerning any matters that might affect the successor's opinion d. disclaim an opinion
indicate in the auditor's report that the predecessor auditor expressed an unqualified opinion
Substantive tests of details of ending balances for investments
inspection, confirmation, recalculation of gains/losses on sale, test of amortization schedules, verification of market value
An auditor issued an audit report that was dual dated for a subsequent event occurring after the date on which the auditor has obtained sufficient appropriate audit evidence but before issuance of the financial statements. The auditor's responsibility for events occurring subsequent to the date on which the auditor has obtained sufficient appropriate audit evidence was a. limited to the specific event referenced b. extended to include all events occurring since the date on which the auditor has obtained sufficient appropriate audit evidence c. extended to subsequent events occurring through the date of issuance of the report d. limited to events occurring up to the date of the last subsequent event referenced
limited to the specific event referenced
The negative request form of accounts receivable confirmation is useful particularly when the assessed level of control risk relative to receivables is, the number of small balances is, consideration by the recipient is a. low, high, likely b. low, low, unlikely c. high, low, likely d. high, high, likely
low, high, likely
Communications with the audit committee (OPTIONAL)
management letter -value added service- conveys suggestions for improvements
Which of the following characteristics most likely would heighten an auditor's concern about the risk of intentional manipulation of financial statements? a. turnover of senior accounting personnel is low b. insiders recently purchased additional shares of the entity's stock c. management places substantial emphasis on meeting earnings projections d. the rate of change in the entity's industry is slow
management places substantial emphasis on meeting earnings projections
Which of the following subsequent events will be least likely to result in an adjustment to the financial statements: a. material changes in quoted market prices of listed investment securities since the balance sheet date b. culmination of events affecting the realization of accounts receivable owned as of the balance sheet date c. material changes in the settlement of liabilities were estimated as of the balance sheet date d. culmination of events affecting the realization of inventories owned as of the balance sheet date
material changes in quoted market prices of listed investment securities since the balance sheet date
Tolerable misstatement is a. the amount of misstatement that management is willing to tolerate in the financial statements b. materiality for the balance sheet as a whole c. materiality for the income statement as a whole d. materiality used to establish a scope for the audit procedures for the individual account balances or disclosures
materiality used to establish a scope for the audit procedures for the individual account balances or disclosures
An advantage of statistical sampling over non-statistical sampling is that statistical sampling helps an auditor to a. eliminate the risk of non-sampling errors b. reduce audit risk and materiality to a relatively low level c. measure the sufficiency of the evidential matter obtained d. minimize the failure to detect errors and fraud
measure the sufficiency of the evidential matter obtained
Inventory and cost of goods sole
measured at cost
As generally conceived, the audit committee of a publicly held company should be made up of a. representatives of the major equity interests (preferred stock, common stock) b. the audit partner, the chief financial officer, the legal counsel, and at least one outside c. representatives from the entity's management, investors, suppliers, and customers d. members of the board of directors who are not officers or employees
members of the board of directors who are not officers or employees
Dart Corporation engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart's financial statements and gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay's opinion was included in Dart's registration statement. Hansen purchased shares in the offering and suffered a loss when the stock declined in value after the misstatements became known. If Hansen succeeds in the Section 11 suit against Dart, Hansen will be entitled to a. damages of three times the original public offering price b. rescind the transaction c. monetary damages comparable to the loss suffered d. damages, but only if the shares were resold before the suit was started
monetary damages comparable to the loss suffered
The permanent file section of the working papers that is kept for each audit client most likely contains a. review notes pertaining to questions and comments regarding the audit work performed b. a schedule of time spent on the engagement b each individual auditor c. correspondence with the entity's legal counsel concerning pending litigation d. narrative descriptions of the entity's accounting system and control procedures
narrative descriptions of the entity's accounting system and control procedures
Incoming cut-off testing
need to determine that inventory purchases and the corresponding accounts payable are recorded in the appropriate period
Outgoing cut-off testing
need to determine that sales of inventory and the corresponding accounts receivable are recorded in the appropriate period
An auditor should perform alternative procedures to substantiate the existence of accounts receivable when: a. no reply to a positive confirmation request is received b. no reply to a negative confirmation request is received c. the collectibility of the receivables is in doubt d. pledging of the receivables is probable
no reply to a negative confirmation request is received
How many paragraphs should the audit report contain?
not addressed
Brown & Company, CPAs, issued an unqualified opinion on the financial statements of its client King Corporation. Based on the strength of King's financial statements, Safe Bank loaned King $500,000. King Corporation and Safe Bank are both located in a state that follows the Ultramares doctrine. Brown was unaware that Safe would receive a copy of the financial statements or that they would be used by King in obtaining a loan. King defaulted on the loan. If Safe commences an action for ordinary negligence against Brown, and Brown believes it will be able to prove that it conducted the audit in conformity with GAAS, Brown will: a. be liable to Safe, because Safe relied on the financial statements b. be liable to Safe, because the statute of frauds have been satisfied c. not be liable to Safe, because there is a conclusive legal presumption that following GAAS is the equivalent of acting reasonably and with due care d. not be liable to Safe, because there was a lack of privity of contract
not liable to Safe, because there was a lack of privity of contract
Completeness assertion: an order was not received, an order received was not recorded as a purchase
numerical sequence of purchase orders, receiving reports, vouchers, receiving reports matched to vouchers, receiving reports to vendor invoices, open purchase order file
Typical purchase transaction controls: Purchases recorded from matched purchase order and receiving report
occurrence
Non-statistical: Calculating the sample results
one way (most common) of projecting the sampling results to the population is to apply ratio estimation (i.e. apply the misstatement ratio in the sample to the rest of the population) E.x. assume the auditor finds $1,500 of misstatements in a sample with a book value of $15,000. The misstatement ratio is 10%.
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "the auditor considers internal control relevant to the entity's preparation and presentation of the consolidated financial statements... but not for the purposes of expressing an opinion"
only in a report prepared under the AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a heading: "adverse opinion"
only in a report prepared under the AICPA reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "we have served as the company's auditor since 1992"
only in a report prepared under the PCAOB reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance "we...are required to be independent with respect to the company..."
only in a report prepared under the PCAOB reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a heading: "Basis for opinion"
only in a report prepared under the PCAOB reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a heading: "Critical audit matters"
only in a report prepared under the PCAOB reporting guidance
in both a report prepared under PCAOB reporting guidance and a report prepared under AICPA reporting guidance a heading: "opinion on the financial statements"
only in a report prepared under the PCAOB reporting guidance
Example of substantive procedures: substantive analytical
perform salaries reasonableness test: obtain prior year average salary per employee from prior year work papers. Estimate current year total salaries by applying current year average pay rate increase and current year number of employees. Compare to client recorded balance and investigate differences in excess of 10%
In connection with the element of engagement performance, a CPA firm's system of quality control should ordinarily include procedures covering all of the following except a. performance evaluation b. consistent, high-quality engagement performance c. supervision responsibilities d. review responsibilities
performance evaluation
Periodic or cycle counts of selected inventory items are made at various times during the year rather than via a single inventory count at year-end. Which of the following is necessary if the auditor plans to observe inventory at interim dates? a. complete recounts are performed by independent auditors b. perpetual inventory records are maintained c. unit cost records are integrated with production-accounting records d. inventory balances are rarely at low levels
perpetual inventory records are maintained
Determine which of the two would provide evidence that is more reliable. physical inspection of widgets in inventory to determine quantity OR physical inspection of widgets in inventory to determine obsolescence
physical inspection of quantity because inspecting for obsolescence is next to impossible
The auditor notes that the company has several small accrued liability accounts that are individually not material, but collectively they amount to a significant balance. The types of activities represented by these accruals are stable from year to year. Design a substantive analytical procedure that tests the VA-Accuracy assertion for each of these individual accrued liability accounts
predict balances based on prior year and compare accrued liabilities is flagged to investigate perform reasonableness test -bigger than 10% difference? -if so, dive in -if not, sign off for example: accrued telephone expense
required by auditing standards to be performed as part of the financial statement audit
preliminary
Which of the following types of audit evidence is the least reliable? a. prenumbered purchase order forms prepared by the entity b. bank statements obtained from the entity c. test counts of inventory performed by the auditor d. correspondence from the entity's attorney about litigation
prenumbered purchase order forms prepared by the entity
Test of details for AR and related accounts: Complete GAAP checklist to ensure all required disclosures have been made
presentation and disclosure
How does the Securities Act of 1933, which imposes civil liability on auditors for misrepresentations or omissions of material facts in a registration statement, expand auditors' liability to purchasers of securities beyond that of common law? a. purchases have to prove only that a loss was caused by reliance on audited financial statements b. privity with purchasers is not a necessary element of proof c. purchasers have to prove either fraud or gross negligence as a basis for recovery d. auditors are held to a standard of care described as "professional skepticism"
privity with purchasers is not necessary element of proof
Decision guidance for non-statistical sampling
projected misstatement: less than expected probable decision: account balance is fairly stated projected misstatement: greater than tolerable misstatement probable decision: account balance is NOT fairly stated projected misstatement: between expected and tolerable probable decision: grey area- use judgment* *AICPA guidance encourages a conservative approach
Purchase cutoff procedures should be designed to test whether all inventory a. purchased and received before the end of the year was paid for b. ordered before the end of the year was received c. purchased and received before the end of the year was recorded d. owned by the entity is in the possession of the entity at the end of the year
purchased and received before the end of the year was recorded
A client has used an inappropriate method of accounting for its pension liability on the balance sheet. The resulting misstatement is moderately material, but the auditor does not consider it to be pervasive. The auditor is unable to convince the client to alter its accounting treatment. The rest of the financial statements are fairly stated in the auditor's opinion. Which kind of audit report would an auditor most likely issue under these circumstances? a. standard unqualified opinion b. qualified opinion due to a departure from GAAP c. adverse opinion d. no opinion at all
qualified opinion due to a departure from GAAP
Internal control is strengthened when the quantity of merchandise ordered is omitted from the copy of the purchase order sent to the a. department that initiated the requisition b. receiving department c. purchasing agent d. accounts payable department
receiving department
To determine whether accounts payable are complete, an auditor performed a test to verify that all merchandise received is recorded. The population of documents for this test consists of all a. vendor invoices b. purchase orders c. receiving reports d. canceled checks
receiving reports
Which of the following internal control activities is most likely to address the completeness assertion for inventory? a. the work-in-process account is periodically reconciled with subsidiary records b. employees responsible for custody of finished goods do not perform the receiving function c. receiving reports are prenumbered and periodically reconciled d. there is a separation of duties between payroll department and inventory accounting personnel
receiving reports are prenumbered and periodically reconciled
In a properly designed purchasing process, the same employee most likely would match vendors' invoices with receiving reports and a. post the detailed accounts payable records b. recompute the calculations on vendors' invoices c. reconcile the accounts payroll ledger d. cancel vendors' invoices after payment
recompute the calculations on vendors' invoices
An auditor would most likely verify the interest earned on bond investments by a. vouching the receipt and deposit of interest checks b. confirming the bond interest rate with the issuer of the bonds c. recomputing the interest earned on the basis of face amount, interest rate, and period held d. testing the controls over cash receipts
recomputing the interest earned on the basis of face amount, interest rate, and period held
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy A considerable amount of control testing is conducted during the "interim" time period between planning and the balance sheet date, with a reduction in the amount of work that must be done after the balance sheet date
reliance
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy control risk has been assessed as low
reliance
Which of the following audit techniques would most likely provide an auditor with the least assurance about the effectiveness of the operation of a control? a. inquiry of entity personnel b. reperformance of the control by the auditor c. observation of entity personnel d. walk through
reperformance of the control by the auditor
Any entity maintains perpetual inventory in both quantities and dollars. If the level of control risk were set at high, an auditor would probably a. insist that the entity perform physical counts of inventory items several times during the year b. apply gross profit test to ascertain the reasonableness of the physical counts c. increase the extent of tests of controls of the inventory system d. request that the entity schedule the physical inventory count at the end of the year
request that the entity schedule the physical inventory count at the end of the year
The physical count of units in inventory was lower than the quantities shown in the perpetual records. This situation could be the result of the failure to record a. sales b. purchase discounts c. sales returns d. purchases
sales
Attribute sampling
sampling used to estimate the proportion of a population that possesses a specified characteristic
Reviewing the general ledger for unusual adjusting entries.
scanning
Which audit procedure goes well with this specific assertion: Verify that recorded accounts payable include all amounts owed to vendors (completeness)
search for unrecorded liabilities
Which of the following procedures is least likely to be performed before the balance sheet date? a. test of internal control over cash b. confirmation of receivables c. search for unrecorded liabilities d. observation of inventory
search for unrecorded liabilities
An auditor ordinarily sends a standard confirmation request to all banks with which the entity has done business during the year under audit, regardless of the year-end balance. One purpose of this procedure is to a. provide the data necessary to prepare a proof of cash b. request that a cutoff bank statement and related checks be sent to the auditor c. detect kiting activities that may otherwise not be discovered d. seek information about loans from the banks
seek information about loans from the banks
Given that cash was prelisted and deposited daily, what internal control deficiency permitted the fraud to occur despite the presence of this control?
segregation of duties --> therefore the list does nothing
Which audit procedure matches with this assertion: determine that recorded accounts receivable include all amounts owed to the client (completeness)
select a sample of shipping documents, match them with related sales invoices, and determine that they have been included in the sales journal and accounts receivable subsidiary ledger
If the financial reporting risks for a location are low and the entity has good entity-level controls, management may rely on which of the following for its assessment? a. documentation and test controls over specific risks b. self-assessment processes in conjunction with entity-level controls c. documentation and test entity-level controls over the entire entity d. selective control test at that location
self-assessment processes in conjunction with entity-level controls
The AICPA Code of Professional Conduct contains both general ethical principles that are aspirational in character and a a. list of violations that would cause the automatic suspension of a CPA's license b. set of specific, mandatory rules describing minimum levels of conduct a CPA must maintain c. description of a CPA's procedures for responding to an inquiry from a trial board d. complete list of all the different kinds of crimes that would be considered as acts discreditable to the profession
set of specific, mandatory rules describing minimum levels of conduct a CPA must maintain
Completeness assertion: a valid order is shipped, but the corresponding sale is not recorded
shipping documents that are prenumbered so you'd see gaps in sales journal, should have fields with these numbers to be on lookout
A number of factors influence the sample size for a substantive test of details of an account balance. All other factors being equal, which of the following would lead to a larger sample size? a. greater reliance on internal controls b. greater reliance on analytical procedures c. smaller expected frequency of misstatements d. smaller amount of tolerable misstatement
smaller amount of tolerable misstatement
All of the following non audit services are identified by the SEC as generally impairing an auditor's independence with respect to an audited entity except a. information systems design and implementation b. human resource services c. management functions d. some specific tax services e. all of the above are seen by the SEC as impairing independence
some specific tax services
When reporting on financial statements prepared on the basis of accounting used for income tax purposes, the auditor should include in the report a paragraph that a. emphasizes that the financial statements have not been examined in accordance with generally accepted auditing standards. b. refers to a tutorial that explains the income tax basis of accounting c. states that the income tax basis of accounting is a basis of accounting other than generally accepted accounting principles d. justifies the use of the income tax basis of accounting
states that the income tax basis of accounting is a basis of accounting other than generally accepted accounting principles
Indicate whether each of the following statements is more consistent with a "substantive" audit strategy or a "reliance" strategy control risk has been set at the maximum
substantive
Regardless of the assessed level of control risk, an auditor would perform some a. test of controls to determine the effectiveness of internal controls b. analytical procedures to verify the design of internal controls c. substantive procedures to restrict detection risk for significant transaction lasses d. dual-purpose tests to evaluate both the risk of monetary misstatement and preliminary control risk
substantive procedures to restrict detection risk for significant transaction lasses
Without the consent of the entity, a CPA should not disclose confidential entity information contained in working papers to a(n) a. authorized quality control review board b. successor CPA firm that has been engaged to audit the former audit entity c. federal court that has issued a valid subpoena d. disciplinary body created under state statue
successor CPA firm has been engaged to audit the former audit entity
Specific audit procedures conducted near completion of audit: examine documents
such as correspondence and invoices from attorneys for pending or threatened lawsuits
UML < TOLERABLE
supports that balance is fairly stated no need to add additional audit procedures beyond those originally planned
The standard report issued by an accountant after reviewing financial statements states that a. a review includes assessing the accounting principles used and significant estimates made by management b. a review includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements c. the accountant is not aware of any material modifications that should be made to the financial statements d. the accountant does not express an opinion or any other form of assurance on the financial statement
the accountant is not aware of any material modifications that should be made to the financial statements
Which of the following statements is correct concerning both an engagement to compile and an engagement to review a non-public entity's financial statements? a. the accountant is not required to obtain an understanding of internal control b. the accountant must be independent in fact and appearance c. the accountant expresses no assurance on the financial statements d. the accountant should obtain a written management representation letter
the accountant is not required to obtain an understanding of internal control
In which of the following situations would an auditor ordinarily issue an unqualified/unmodified financial statement audit opinion with no explanatory (or emphasis-of-matter/other matter) paragraph? a. the auditor wishes to emphasize that the entity had significant related-party transactions b. the auditor decides not to refer to the report of another auditor as a basis, in part, for the auditor's opinion c. The entity issues financial statements that present financial position and results of operations but omits the statement of cash flows d. the auditor has substantial doubt about the entity's ability to continue as a going concern, but the circumstances are fully disclosed in the financial statements
the auditor decides not to refer to the report of another auditor as a basis, in part, for the auditor's opinion
Which of the following statements concerning control deficiencies is true? a. the auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit b. all significant deficiencies are material weaknesses c. all control deficiencies are significant deficiencies d. an auditor must immediately report material weaknesses and significant deficiencies discovered during an audit to the PCAOB
the auditor should communicate to management, in writing, all control deficiencies in internal control identified during the audit
Under which conditions would an online dating company be more likely to opt for a SOC 3 report over a SOC 2 report? a. the company wishes the report to be distributed only to a restricted set of users who understand the details of the IT system being reported on b. the company wishes to obtain a report that provides assurance as to its internal control over financial reporting in accordance with COSO's internal control framework c. the company's auditor is seeking evidence that the company's data is being processed with integrity d. the company wishes to disseminate the report broadly to convince potential users of its website that their information will be kept confidential and private
the company wishes the report to be distributed only to a restricted set of users who understand the details of the IT system being reported on
Samples to test internal controls are intended to provide a basis for an auditor to conclude whether a. the controls are operating effectively b. the financial statements are materially misstated c. the risk of incorrect acceptance is too high d. materiality for planning purposes is at a sufficiently low level
the controls are operating effectively
Which of the following would an auditor most likely use in determining overall materiality when planning the audit? a. the anticipated sample size of the planned substantive tests b. the entity's income before taxes for the period-to-date (e.g. 6 months) c. the results of rest of controls d. the contexts of the engagement letter
the entity's income before taxes for the period-to-date (e.g. 6 months)
Which of the following assurances is not provided by compliance with Trust Services principles? a. there are procedures to protect the system against unauthorized physical access b. the financial statements created by the system are free of material misstatements c. the documented system availability objectives, policies, and standards have been communicated to authorized users and control are functioning as documented d. documented system processing integrity objectives, politics, standards have been communicated to authorized users and controls are functioning as documented
the financial statements created by the system are free of material misstatements
Probable
the future event is likely to occur
Monitoring is a major component of the COSO Internal Control—Integrated Framework. Which of the following is not correct in how the company can implement the monitoring component? a. monitoring can be an ongoing process b. monitoring can be conducted as a separate evaluation c. monitoring and other audit work conducted by internal audit staff can reduce external audit costs d. the independent auditor can serve as part of the entity's control environment and continuous monitoring
the independent auditor can serve as part of the entity's control environment and continuous monitoring
Non-statistical: Identifying individually significant items
the items to be tested individually are items that may contain potential misstatements that individually exceed the tolerable misstatement. These items are tested 100% because the auditor is not willing to accept any sampling risk for these items e.g. all customer accounts over $100,000 will be selected for confirmation
Which of the following statements concerning audit evidence is correct? a. to be appropriate, audit evidence should be either persuasive or relevant but need not be both b. the measure of the reliability of audit evidence lies in the auditor's judgment c. the difficulty and expense of obtaining audit evidence concerning an account balance are a valid basis for omitting the test d. an entity's general ledger may be sufficient audit evidence to support financial statements
the measure of the reliability of audit evidence lies in the auditor's judgment
Dart Corporation engaged Jay Associates, CPAs, to assist in a public stock offering. Jay audited Dart's financial statements and gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Jay's opinion was included in Dart's registration statement. Hansen purchased shares in the offering and suffered a loss when the stock declined in value after the misstatements became known. In a suit against Jay and Dart under the Section 11 liability provisions of the Securities Act of 1933, Hansen must prove that a. Jay knew of the misstatements b. Jay was negligent c. The misstatements contained in Dart's financial statements were material d. The unqualified opinion contained in the registration statement was relied on by Hansen
the misstatements contained in Dart's financial statements were material
Assume an auditor is evaluating a statistical attribute sample of 50 items that resulted in three deviations. What should the auditor conclude if the tolerable deviation rate is 7 percent, the expected population deviation rate is 5 percent, and the allowance for sampling risk is 2 percent? a. the planned assessed level of control risk should be modified because the tolerable deviation rate plus the allowance for sampling risk exceeds the expected population deviation rate b. the sample results should be accepted as support for the planned assessed level of control risk because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable deviation rate c. the sample results should be accepted as support for the planned assessed level of control risk because the tolerable deviation rate less the allowance for sampling risk equals the expected population deviation rate d. the planned assessed level of control risk should be modified because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable deviation rate
the planned assessed level of control risk should be modified because the sample deviation rate plus the allowance for sampling risk exceeds the tolerable deviation rate
DR = (AR)/(IR*CR)
the planned level of detection risk determines the amount of evidence needed (inversely related)
Fair value
the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Desired confidence level
the probability that the true but unknown measure of the characteristic of interest is within specified limits
Confirmation
the process of obtaining and evaluating direct communication from a third party in response to a request for information about a particular item affecting financial statement assertions
Which of the following statements is correct concerning statistical sampling in tests of controls? a. Deviations from controls at a given rate usually result in misstatements at a higher rate b. As a population size doubles, the sample size should also double c. The qualitative aspects of deviations are not considered by the auditor d. There is an inverse relationship between the sample size and the tolerable deviation rate
there is an inverse relationship between the sample size and the tolerable deviation rate
Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions? a. to achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly executive, captured, and processed. b. to achieve its strategies, a business formulates objectives and implements processes, which are carried out through the entity's information and internal control systems. Transactions are conducted to ensure that the processes are properly executed, captured, and processed c. To achieve its objectives, a business formulates strategies to implement its transactions, which are carried out through business processes. The entity's information and internal control systems must be designed to ensure that the processes are properly executed, captured, and processed. d. to achieve its business processes, a business formulates objectives, which are carried out through the entity's strategies. The entity's information and internal control systems must be designed to ensure that the entity's strategies are properly executed, captured, and processed.
to achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly executive, captured, and processed.
Which type of test and management assertion goes with this test: (1)Verify whether client uses pre-numbered receiving reports and follows up on any sequence gaps. (2)Trace a sample of these reports to related entries in the purchases journal to determine that they were recorded
type of test: (1) test of controls (2) substantive test of transactions management assertion: completeness
Which type of test and management assertion goes with this test? Compare purchase returns and allowances as a percentage of costs of sales to prior year and to industry data
type of test: substantive analytical procedure management assertion: accuracy
Which type of test and management assertion should be used for the following test: Determine whether client uses pre-numbered shipping documents and accounts for the sequence Examine a sample of shipping documents to determine whether a duplicate sales invoice is attached indicating that the shipment was billed
type of test: substantive test of transactions management assertion: completeness
Type of liability: tort
typical plaintiffs: client or third parties (some limitations depend on jurisdiction)
When using confirmation to provide evidence about the completeness assertion for accounts payable, the appropriate population most likely would be a. vendors with whom the entity has previously done business b. amounts recorded in the accounts payable subsidiary ledger c. payees of checks drawn in the month after year-end d. invoices filed in the entity's open invoice file
vendors with whom the entity has previously done business
Cable Corporation orally engaged Drake & Company, CPAs, to audit its financial statements. Though the financial statements Drake audited included a materially overstated accounts receivable balance, Drake issued an unqualified opinion. Cable used the financial statements to obtain a loan to expand its operations. Cable defaulted on the loan and incurred a substantial loss. If Cable sues Drake for negligence in failing to discover the overstatement, Drake's best defense would be that Drake did not: a. have privity of contract with Cable b. sign an engagement letter c. perform the audit recklessly or with an intent to deceive d. violate generally accepted auditing standards in performing the audit
violate generally accepted auditing standards performing the audit
Auditing standards require auditors to make certain inquiries of management regarding fraud. Which of the following inquiries is required? a. whether management has ever intentionally violated the securities laws b. whether management has any knowledge of fraud that has been perpetrated on or within the entity c. management's attitudes toward regulatory authorities d. management's attitude about hiring ethical employees
whether management has any knowledge of fraud that has been perpetrated on or within the entity
Considering each independently, a change in which of the following sample planning factors would influence the sample size for a substantive test of details for a specific account? Expected misstatement, Tolerable misstatement a. no, no b. yes, yes c. no, yes d. yes, no
yes, yes
tort law concepts: fraud
-knowledge of falsity and intent to deceive (scienter) -generally clients and all 3rd parties can sue
tort law concepts: gross negligence/constructive fraud
-lack of even slight care, but no intent to deceive (recklessness) -generally clients and all 3rd parties can sue
Audit field work for the audit of Diablo Oil Company's December 31, 20X3 financial statements was completed on March 8, 20X4. Diablo is a large public company, and no issues with the company's ICFR were noted. During the audit the controller, Tracy Tricks, refused to allow the auditors to confirm accounts receivable, stating that she was concerned about these confirmations generating complaints from customers. Although they tried to use alternate procedures to audit accounts receivable, the auditors were unable to completely satisfy themselves about the accounts receivable balance, which is material to the financial statements. The auditors remain extremely uncomfortable and suspicious of Tracy's reasons for not allowing confirmation of A/R, and consider this is a significant limitation on their ability to gather necessary evidence to form an opinion.
-Type of Audit Opinion: Disclaimer of Opinion -Additional Paragraph content: A discussion of the scope limitation, and the balances of the financial statement accounts affected. -Paragraph location: within the "disclaimer of opinion on the financial statements" section, after the first paragraph -Paragraph heading: non -Additional paragraph content: references the unqualified opinion on ICFR -Paragraph location: at the end of the "opinion on the financial statements" section -Paragraph heading: none -Report date: March 8, 20X4
Audit field work for the audit of Georgia Corp's December 31, 20X3 financial statements was completed on February 26, 20X4. Georgia is a large public company, and a material weakness was detected in ICFR. During audit fieldwork a problem was discovered with the valuation of Oregon's finished goods inventory, whereby the necessary LCNRV adjustments were not recorded. As a result, the ending inventory balances are materially misstated, and management has refused to make adjustments. These misstatements are not pervasive to the financial statements.
-Type of audit opinion: Qualified- GAAP Departure -Additional paragraph content: gives a discussion of the GAAP departure in the inventory account related to the LCNRV evaluation, and quanitfies the impact on the inventory and related income statement accounts affected. -Paragraph location: Within the "Opinion on the Financial Statements" section, after the first paragraph that gives the opinion. -Paragraph heading: none -Additional Paragrah content: references the adverse opinion on ICFR -Paragraph location: at the end of the "Opinion on the Financial Statements" section -Paragraph heading: none -Report date: February 26, 20X4
Audit field work for the audit of Delaware Digital Corp.'s December 31, 20X3 financial statements was completed on February 26, 20X4. Delaware is a small public company. On March 8, before the financial statements were issued, Delaware's factory was destroyed by a hurricane. The building and machinery were not salvageable, and Delaware is not insured for casualty losses. Delaware has disclosed this information in Note 19 to the financial statements. The auditors applied limited additional procedures to the hurricane loss, and have determined that the information in the note is fairly stated.
-Type of audit opinion: unqualified-emphasis paragraph -additional paragraph content: As discussed in Note 19, Delaware Digital Corp. suffered an uninsured casualty loss on March 8, 20X3. -paragraph location: within the "opinion on the financial statements" section, after the first paragraph that gives the opinion -paragraph heading: none -Report date: February 26, 20X4, except for Note 19, for which the date is March 8, 20X3
Self-interest: Indirect Financial Interest
-a financial interest beneficially owned through an investment vehicle or other intermediary where the beneficiary does not control or participate in the investment decisions. Example: an investment in a mutual fund that owns the client's stock. -PERMITTED for covered member's and immediate family as long as they are not material to the person's wealth -OK for close relatives, unless material to the person's wealth -If a covered member owned 5% or less of a diversified mutual fund- the underlying investments are automatically considered to be immaterial indirect financial interests
Self-interest (Direct Financial Interest)
-a financial interest in an attest client such as ownership of an equity or debt security, or a loan to or from the client -PROHIBITED for covered members and immediate family, regardless of materiality -OK for close relatives, unless amount if material to the person's wealth -ownership by ANY partner or professional member of the firm (even if not covered members), or their immediate family, or any group of these people together, of more than 5% of the client's outstanding stock, is a prohibited direct ownership interest ***some previous loans (home mortgages, secured loans, and immaterial unsecured loans) are permitted [grandfathered] as long as they were made under normal lending procedures and are kept current. new collateralized personal loans, and credit card balances <$10,000 are permitted, as long as they were made under normal lending procedures are are kept current***
Positive confirmation process
-a response is expected whether the customer agrees or disagrees with the balance indicated -must send second requests/do alternate procedures for non-responses -generally for large individual balances, or where RMM is deemed to be high
Corporate Governance
-a system of people, processes, and activities in place to help ensure appropriate behavior by a company and its agents, and proper stewardship over the company's assets -in a corporate governance system, managers and their actions are overseen, supervised, and monitored primary parties -management -stockholders -auditors (internal and external) -board of directors -audit committee -regulators -other stakeholders
Auditing (a special type of attest engagement)
-a systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results of interested users. -responsible part (management claims that certain information (financial statements) corresponds with certain criteria of GAAP) -auditor collects and evaluates evidence to determine whether this claim is true, and issues a report
Type 1 Event
-additional information about conditions that existed AT the balance sheet date -affects estimates that are part of the financial statements -require adjustment of the financial statements (if possible)
Common law damages
-compensatory -punitive (punishment) 1. for constructive fraud or fraud 2. these are not available under federal statutes -proportionate 1. some states allow joint and several if apportionment is not possible
Auditing Accounting Applications Processed by Service Organizations
-an audit client may have some transactions processed by an outside servicer -the servicer's controls must be considered in the assessment of the client's internal controls OPTIONS 1. visit the servicer, obtain understanding of controls and test if reliance is planned 2. servicer retains its own independent auditor to assess controls. that auditor issues a report (SOC 1), which can then be given to the auditors of the servicer's customers
Members in business
-are employed to perform accounting functions for a company -e.g. Coca-cola's internal auditors, corporate accountants, cost accountants, in-house ta accountants
Valuation or allocation (sub-components) -accuracy (includes math, posting, and tie-in) -cut-off -classification -valuation/realizable value
-asset, liability, equity, revenue, and expense components have been included in the financial statements at the appropriate amounts
Private Securities Litigation Reform Act of 1995
-attempts to discourage 'deep pockets' suits against audits; makes it more difficult for a plaintiff to bring a frivolous suit -replaces joint and several with proportionate liability
Attest Services
-attest services occur when a practitioner (CPA) is engaged to issue or does issues a report on subject matter, or an assertion about subject matter, that is responsibility of another party -responsible party has claimed that information corresponds with certain criteria -CPA issues a report attesting to whether this claim is true
1. Breach of Contract
-auditor fails to complete services agreed to in the contract with the client -examples 1. failure to issue appropriate opinion in accordance with engagement type 2. failure to complete work by designated deadline 3. quitting an engagement without adequate cause (client acceptance decision --> due diligence)-once accepted, must follow through, engagement letter is essentially the contract, must be in writing -defenses 1. client breach; no client loss -engagement letter 1. spells out specific responsibilities. auditing standards require these to be in writing (although generally, even verbal contracts are enforceable)
Types of audit sampling: auditing standards recognize and permit statistical and non-statistical methods Non-statistical sampling (or judgmental sampling)
-auditor is not required to use statistical techniques to determine sample size, select sample items, or evaluate results. Much of this is left to the auditor's judgment -not able to quantify allowance for sampling risk
Subsequent discovery of facts
-auditor is not responsible for making inquiries after this report date -however, sometimes facts that existed at the report date do not come to the auditor's attention until after the report date has been issued -if these facts would affect the auditor's opinion (1)consult an attorney (2) notify the client ASAP (3) request client to restate financial statements and add a footnote; revise audit opinion; have client notify persons who may be relying on financial statements --> for public companies, SEC and exchanges need to be notified -client refusal to cooperate: auditor should (1) notify BOD (2) withdraw the audit opinion (3)notify known users and regulators about withdrawal of opinion
Auditing petty cash
-balance not usually material, but petty cash presents an opportunity for theft -testing usually consists of limited control testing -at any given time, the sum of the cash in the box + receipts representing legitimate uses of petty cash should equal the balance of the fund
Special reports
-basis of accounting other than GAAP -report on specific items rather than the financial statements as a whole -regulatory compliance reports (negative assurance)
Pay special attention to transfers where:
-book disbursement date is later than book receipt date, and they cross fiscal year end. This will result in the same cash being counter twice (Kiting) -bank deposit date precedes book receipt date for the same account (trying to cover up shortage) -bank disbursement date precedes book disbursement date for the same account (poor controls over timely recording) -the book disbursement date precedes year end, while the book receipt date is in the next fiscal year (cash "disappears" and is not reflected on the books of either account at 12/31)
auditing an accounting estimate complicating factors
-can't just vouch back to an invoice to verify the "right" answer -many assumptions and unknowns go into the client's calculations -management may introduce bias into their estimates
Legal letters: primary source of information about litigation claims, and assessments
-client's management requests attorneys to provide information to the auditor -materiality guidance and fieldwork completion date are given to the attorneys -client's in-house general counsel and external attorneys -actual and pending claims -unasserted claims: corroborate management's understanding *refusal of the attorney to furnish a legal letter is a scope limitation causing the auditor to not issue an opinion leading to a disclaimer*
Substantive Analytical Procedures for the Purchasing process
-compare payables turnover and days outstanding in accounts payable to previous years' and industry data -compare current-year balances in accounts payable and accruals with prior years' balances -compare amount owed to individual vendors in the current year's amounts owed in prior years -compare purchase returns and allowances as a percentage of revenue or cost of sales to prior years' industry data
Key substantive tests related to inventory
-compare raw material, finished goods, and total inventory turnover to previous years and industry averages (obsolete, slow-moving, or excess inventory) -compare days outstanding in inventory to previous years and industry average (obsolete, slow-moving, or excess inventory) -compare quarterly gross profit percentage by product line with quarterly values in previous years and industry data (unrecorded or fictitious inventory) -compare actual costs of goods sold to budgeted amounts (over or under stated inventory) -compare current-year standard costs with prior years after considering current conditions (over or under stated inventory) -compare quarterly actual manufacturing overhead costs with quarterly budgeted or standard manufacturing overhead costs (inclusion or exclusion of overhead costs)
Consideration of Fraud in a Financial Statement Audit (Old SAS 99)
-emphasizes the auditor's responsibility for detecting material fraud -identifies conditions for fraud and fraud risk factors -revenue accounts: analytical procedures required; presumption of RMM due to fraud -emphasizes the importance of skepticism and brainstorming -requires inquiry specifically about fraud -requires that all fraud procedures be documented -gives guidance on communicating findings
Errors vs. Fraud
-errors are unintentional misstatements -mistakes in gathering or processing financial data used to prepare financial statements 1. unreasonable accounting estimates arising from oversights or misinterpretation of facts 2. mistakes in the application of accounting principles relating to amount, classification, number or presentation, or disclosure -fraud involves intentional misstatements
Investments primary concerns
-existence -authorization -VA-Classification (different accounting rules for investments and how they show up on financials depending on the classification given; Cost/MV or gains/losses) -VA-Accuracy (particularly gains/losses) -VA-Valuation -Presentation and disclosure
Class Action Fairness Act of 2005
-extends federal jurisdiction; to curb abuses seen in nationwide class action suits filed in state courts
Services where no assurance is given
-financial statement compilation 1. management provides financial information and accountant assembles it into the form of financial statement; no inquiries or testing required 2. report is issued, but no assurance is given 3. guidance for AICPA Statements on Standards for Accounting and Review Services (SSARS) -financial statement preparation 1. guidance from SSARS; no report issued -tax -consulting/management advisory
PCAOB Inspections of Registered Fi
-frequency depends on number of public clients -reports 1. part I: publicly available (general findings) 2. part II: details of violations publicized if the firm does not take adequate corrective action within 1 year -recent trends 1. ICFR audits 2. criticism of substantive analytical procedures difficulties encountered inspecting foreign firms
The standard unmodified opinion for a non-public company is issued when the auditor has
-gathered sufficient evidence -the audit was performed in accordance with GAAS -the financial statements conform to GAAP
Dodd-Frank 2010
-gave PCAOB authority to inspect foreign audit firms that practice in the US -exempts small public companies (<$75 million market cap) from audit of ICFR
2. Allocate PM to Accounts (Tolerable Misstatements)
-generally start with a quantitative benchmark (e.g., a % of PM) -adjust for qualitative factors 1. expectation of errors in the account 2. size and complexity of the account 3. fraud risk associated with the account 4. relation between the account and key performance indicators and debt covenants
What is the possible impact on an auditor when a company fails or suffers a significant loss in value?
-generally, investors and creditors want to assign blame for their loss, and hopefully recover some of their loss from someone -auditors have become a convenient target because of their "deep pockets" -auditors often finds themselves the defendant in a law suit sometimes it is warranted, sometimes not...
Auditing- different from other accounting courses
-given a set of financial statements --> determine whether they conform with GAAP How should we test in order to figure that out? -less quantitative/more conceptual -focus on analytical and logical skills
Financial accounting
-given specific transactions or events --> determine how they should be recorded and appear in the financial statements -quantitative -concrete right answer
Public's view of the auditor's role
-guarantee the complete accuracy of the financial statements -guarantee the financial viability of the business/good investment -guarantee that all instances of fraud will be detected
Another type of auditing: Internal auditing
-independence vs. objectivity -assurance and consulting -IIA (institute of internal auditors) 1. professional association 2. standards, code of ethics, CIA certification -in-house vs. co-sourced -role in the external audit
inherent risk factors for inventory management process
-industry related factors (valuation issues due to obsolescence, volatile prices, competition) -client-specific factors (difficulty of valuing unique items, susceptibility to theft) -prior year misstatements
Inherent risks pertaining to the purchasing process
-industry-related factors (is the supply of raw materials adequate?) (how volatile are raw material process? -misstatements in detected prior audits
IASB
-international counterpart to the FASB
Major functions of the inventory management process
-inventory management: authorization of production activity and maintenance of inventory at appropriate levels; issuance of purchase requisitions to the purchasing department -raw materials stores: custody of raw materials and issuance of raw materials to manufacturing departments -manufacturing: production of goods -finished goods stores: custody of finished goods and issuance of goods to the shipping department -cost accounting: maintenance of costs of manufacturing and inventory in cost records -general ledger: proper accumulation, classification, and summarization of inventory and related costs in the general ledger
Other information in documents containing audited financial statements
-is the auditor responsible for the accuracy of the other information that is not part of the financial statements 1. e.g. the annual report document contains MD&A and other discussion from management about how the company has done during the past year -Answer yes or no 1. not responsible for auditing all of this information 2. but to the extent that other information is related to information contained in the audited financial statements, the auditor must read the other information to ensure that it is not inconsistent with what the auditor has audited
SOX Section 404 Requires the annual report of every public company to include information on internal controls Auditor's report
-issued by the same firm that audits the company's financial statements -gives the auditor's opinion on the effectiveness of ICFR (reasonable assurance; all material aspects) -small public companies (market cap<$75 million) are exempt from this requirement
Management assertions- the building block of the audit
-management assertions that the financial statements are "correct" (i.e. in conformity with GAAP). It is the auditor's job to test that assertion -"correct" is a very general concept. There are actually multiple underlying ways the financial statements can end up NOT "correct" -the auditor has to figure out how to test all of these "angles"
FASB Guidance [Accounting Standards Update 2014-2015]
-management must evaluate likelihood of continuing 1 year beyond issuance of financial statements -if there is substantial doubt, note disclosure is required (1)if a plan exists to turn things around -> must discuss in note disclosure (2) if no adequate plan exists -> disclose substantial doubt about ability to continue as a going concern
Independence Reality Check
-many firms have firm-specific policies that are more stringent than the AICPA rules -annual disclosure statement 1. honest self reporting is extremely important 2. when in doubt, disclose it 3. trying to hide things or "pretend" that you didn't realize it was a problem can get you and your firm in trouble
Monitoring controls
-monitoring of controls is a process that assesses the quality of internal control performance over time -principles include: 1. monitoring can be accomplished through ongoing activities or separate evaluation 2. deficiencies should be communicated in a timely manner so that appropriate corrective action can be taken
Auditing the Tax Provision and Related Balance Sheet Accounts: Use of Specialists
-multiple locations/foreign operations -business combinations -changes in ownership or tax status -accounting for uncertain tax positions -deferred tax assets-valuation issues
Non-public company reports
-new guidance (AU-C section 700) has been adopted. It will be effective for audits of fiscal years ending on or after 12/15/21 -note: new guidance is typically testable on the CPA exam 6 months after it becomes effective -the existing (old) guidance should be tested until mid-2021, so we will cover the existing (old) guidance. If you plan to take the AUD section of the exam later, you will need to study the new guidance
Advertising and Other Forms of Solicitation Rule (1.600)
-not allowed to seek clients by using advertising or other solicitation that is false, misleading, or deceptive 1. cannot create unjustified expectations about results 2. cannot mislead about fee if the fee is likely to be higher -use of coercion, over-reading, or harassing conduct is prohibited
Steps in MUS: Planning
-objective of the test -population characteristics 1. sampling population 2. sampling unit 3. misstatement -determine sample size required 1. desired confidence level 2. expected misstatement 3. tolerable misstatement 4. population size
Should we accept this engagement? New (prospective) clients
-obtain and review financial information -make 3rd party inquiries about management -communicate with predecessor auditor -consider unusual business risks, audit risks, engagement risks -determine whether the firm has the necessary technical skills/knowledge -determine whether the firm is independent
Testing the client's bank reconciliation
-obtain client-prepared reconciliation and any supporting schedules (ex. outstanding check list, list of deposits in transit etc.) -test mathematical accuracy -obtain bank confirmation and cut-off (post balance sheet bank information) -tie out totals and reconciling items to sources of verification (ex. to the GL balance; to bank confirmation; to clearance on bank statements) -tick mark legend should describe exactly the procedures performed -cross referencing should tie related work papers together -verify that client has recorded any necessary adjusted journal entries
Search for unrecorded liabilities may include the following procedures
-obtain copies of vendors' monthly statements and reconcile to the client's accounts payable records (compare vendor and client discrepancies) -confirm vendor accounts, including accounts with small or zero balances (where appropriate) - test of subsequent disbursements; examine documentation for large-dollar items from the cash disbursements journal for a limited time after year-end, noting dates on supporting documentation. For items that should have been accrued as of 12/31, determine whether they were properly accrued -examine the files of open purchase orders, receiving reports, and unpaid vendor invoices for any unrecorded liabilities
Form of Organization and Name Rule (1.800)
-only organizational forms that are permitted by law are allowed (for firms that provide attest services, a majority of the financial interest in the firm must be owned by the CPAs) -firm name cannot be misleading -names of past owners are permitted -firm cannot designate itself as "Members of the AICPA" unless all CPA owners are members of the AICPA
SEC Independence Rules: Human Resource Issues
-partners (lead and review) limited to 5 consecutive years on a client, with a 5-year time out before returning -a one-year "cooling off" period is required for employees taking a "financial reporting oversight role***" who previously worked on the audit engagement at the CPA firm performing the audit ***problematic at the "C-level" positions of CEO, CFO, Controller, Chief Accounting Officer*** PCAOB continues to investigate ways to enhance auditor independence and skepticism. One topic that has been considered: mandatory audit firm rotation
Examples of contingent liabilities
-pending or threatened litigation -actual or possible claims and assessments -income tax disputes -product warranties or defects -guarantees of obligations to others -agreements to repurchase receivables that have been sold
Final evaluation of evidence
-perform final analytical procedures -review working papers -obtain a representation letter -evaluation of financial statement presentation and disclosure -obtain an independent review of engagement -evaluate entity's ability to continue as a going concern -final evaluation of audit results -file the work papers
Inventory testing usually includes
-physical inventory observation -testing client's inventory compilation -price tests -cut-off testing
Inherent risk factors to keep in mind for the revenue process
-the complexity and contentiousness of revenue recognition issues and transactions and applicable revenue recognition rules -subjectivity of accounts balances (e.x. estimates of the allowances) -misstatements detected in prior audits -industry-related factors -difficulty of auditing transactions and account balances
Documents and records included in the inventory management process
-production schedule: production schedules determine the quantity of goods needed and the time at which goods must be read in order to meet demand -receiving report: records the receipt of goods from vendors -materials requisition: normally used to track materials during the production process -inventory master file: contains all the important information related to the entity's inventory, including the perpetual inventory records -production data information: production information about the transfer of goods and related cost accumulation at each stage should be reported -cost accumulation and variance report: cost accumulation report summarized the various costs charged to departments and products. the variance report presents the results of inventory processing in terms of actual costs versus standard or budgeted costs -inventory status report: shows the type and amount of products on hand -shipping order
typical documents and records in the purchase process
-purchase requisition: request to purchase goods or services -purchase order: includes description, quality, and quantity of goods or services being purchased -receiving report: records the receipt of goods -vendor invoice: the bill from the vendor -voucher: serves as the basis for recording a vendor's invoice -voucher register: used to record vouchers for goods and services -purchase journal (DR purchases/inventory or operating expense CR accounts payable) -A/P subsidiary ledger: includes amount owed to individual vendors -vendor statement: represents the purchase activity with vendor -check (or EFT): pays for goods or services -cash disbursement journal (check register): contains columns to record credits to cash and debits to accounts payable and cash discounts
Purchasing process-Common analytical procedures for purchases process on balance sheet
-reasonableness test for various other accrued expenses (comparison to prior year) -aging categories within accounts payable -A/P turnover - comparison of amount owed to significant vendors vs. prior year balances
Substantive analytical procedures for the revenue process
-receivables turnover and days outstanding in accounts receivable -aging categories on aged trial balance of accounts receivable -bad-debts expense as a percent of revenue -allowance for uncollectible accounts as a percent of accounts receivable or credit sales -large customer account balances compared to last period
Liability and Expense Issues
-recording expenses in the appropriate period -capitalizing vs. expensing - cut-off issues (particularly delaying recording of liabilities)
Explanatory paragraph (at end of opinion section) [required]
-reference the report of other auditors (also modify wording in opinion and basis for opinion sections) -going-concern issues -change in accounting principle -restatement to correct prior misstatement -auditor not required to audit ICFR
Ethics (philosophy classes)
-refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should behave in society -analysis of ethical issues can lead to differing outcomes, depending on the ethical theory employed e.g. Utilitarianism; rights-based; justice-based
Professionalism (accounting professionals - AICPA gives guidance)
-refers to the conduct, aims or qualities that characterize a professional person or a profession -a code of professional conduct provides guidance for expected behaviors
Negative Confirmation Process
-requests that the customer respond only when they disagree with the amount owed to the client -no second requests/alternate procedures required -typically used when the client has many small accounts balance and control risk is assessed as low
SEC
-requires public companies to file annual (10-K) and quarterly (10-Q) financial statements
Types of transactions and financial statement accounts affected by the revenue process
-sales transactions: trade accounts receivable, sales, allowance for uncollectible accounts, bad-debt expense -cash receipts transactions: cash, trade accounts receivable, cash discounts -sales returns and allowance transactions: sales returns, sales allowances, trade accounts receivable
Steps in attribute sampling: Performance of the test
-select sample items 1. method MUST be random -random number generator -systematic selection (interval) with random start -perform the audit procedures 1. examine supporting documentation and determine whether any deviations exist 2. special issues -voided/unused/inapplicable documents/alternates -inability to examine a sample item -stopping the test early
Steps in MUS: Performance of the test
-select sample items 1. systematic selection method (called probability proportional to size) with random start and interval -each individual dollar in the population has an equal chance of being selected. Larger accounts have a greater chance of being selected because they contain more dollars -perform the audit procedures 1. the auditor conducts the planned audit procedures on the logical units (customer accounts) containing the selected dollar sampling -e.g., send A/R confirmations to all individual customers whose accounts contained at least one of the sample dollars that was selected
Bank reconciliation basics
-should be prepared by the client, auditor tests the reconciliation on monthly basis (auditor is testing the control in place and the ending balance of the cash balance) -bank-to correct/book-to-correct balance format -reconciling items -reconciling items in the book-to-correct balance section require adjusting journal entry
What is the role of the IAASB? Does the IAASB have power or jurisdiction over any auditors? Can the IAASB force compliance with their standards?
-standards setting body -companies can voluntarily adopt if they want
Testing client's inventory compilation
-test mathematical accuracy -check for legitimate supporting tag numbers -trace auditor's test counts into the compilation -verify accuracy of unit prices used (supported by price test) -trace total into the general ledger
gathering evidence during the post-balance sheet period is commonly used in
-testing estimates -uncovering excessive returns (aggressive revenue recognition) -searching for unrecorded liabilities
Control Environment
-tone at the top -actions, policies, and procedures that reflect the attitudes of management, directors, and owners -Principles include 1. commitment to integrity and ethical values 2. board of directors oversight 3. communication of reporting lines and responsibilities 4. commitment to competence 5. accountability
Fraud related audit procedures: four column proof of cash
-two consecutive month-end reconciliations, with inner columns for receipts and disbursements that occurs during the intervening month -in addition to verifying the ending balance, also allows total receipts per the cash receipts journal and total disbursements per the cash disbursements journal to be verified to the bank's records
Preliminary Analytical Procedures (performed during Planning) Purpose: to help plan the audit and highlight areas where additional audit effort is needed
-typically incorporates high level ratio analysis and trend analysis KEEP IN MIND -ratios in isolation don't give much useful information -need a benchmark for comparison (e.g. pas years, industry data, expectation, etc.) -not necessarily looking for "bad" results- looking for relations that are not as expected
Final analytical procedures (required)
-used as an overall review of the financial information in the final review stage of the audit -generally done at at "high" level
Members in public practice
-works for a public accounting firm -have multiple clients who pay them to perform specific services -the clients can be publicly traded companies and nonpublic companies -e.g. professional employees of EY; a sole proprietor who runs a small tax practice
Attest services: 3 categories (governed by the ACIPA's Statements on Standards for Attestation Engagement (SSAEs)
1. Examination (opinion gives positive assurance; analogous to an "audit") -financial forecasts based on expected conditions -financial projections based on hypothetical assumptions 2. Review (conclusions gives negative assurance) -no information was discovered that indicates a lac of compliance, or a need for modification -scope of procedures is less than for an examination or audit 3. Agreed-upon procedures (level of assurance varies) -report on findings based on specific procedures performed -level of assurance depends on nature and scope of services -distribution of report is limited to the parties to the agreement
Norm Nelson, CPA used a non-statistical approach to perform a confirmation test of a client's accounts receivable balance as of November 30, 20X1. The following information relates to the test: Number of accounts: -total accounts receivable at 11/30: 1,500 -stratified information: -accounts > $50,000: 10 -accounts > $5,000 (up to $50,000): 440 -accounts $5,000 or less: 1,050 -tolerable misstatement for A/R: $155,000 -expected misstatement: $55,000 Total dollar balance: -total accounts receivable at 11/30: $5.5 million -stratified information: -accounts > $50,000: 750,000 -accounts > $5,000 (up to $50,000): 3,000,000 -accounts $5,000 or less: 1,750,000 -all individual customer account balances greater than $50,000 will be selected for confirmation. -a sample of 57 account balances smaller than $50,000 will be selected for confirmation
1. How many accounts receivable confirmations will Norm need to send?: 67 2. Norm Nelson confirmed the accounts receivable customer accounts selected, and noted the following results: Stratum > $50,000 -Book value of stratum: $750,000 -Book value of sample: $750,000 -Audit value of sample: $746,500 -Amount of misstatement: $3,500 Stratum > $5,000 -Book value of stratum: $3,000,000 -Book value of sample: $910,000 -Audit value of sample: $894,750 -Amount of misstatement: $15,250 Stratum $5,000 or less -Book value of stratum: $1,750,000 -Book value of sample: $70,000 -Audit value of sample: $66,450 -Amount of misstatement: $3,550 Use ratio estimation to determine projected misstatement. 1. 3,500/750,000* 750,000= 3,500 2. 15,250/910,000*3,000,000-50,275 3. 3,550/70,000-1,750,000= 88,750 3. What conclusion should Norm Nelson make about the accounts receivable balance? Explain your reasoning. --> EM < $142,525 < TM high risk that the account balance is materially misstated
Audit report structure- Non-public company
1. Independent Auditor's Report 2. To the shareholders of Jelly Corp. 3. Report on the Financial Statements 4. Management's Responsibility for the Financial Statements 5. Auditor's Responsibility 6. auditing standards generally accepted in the United States of America 7. audit evidence 8. internal control 9. Opinion 10. fairly, in all material respects 11. accounting principles generally accepted in the United States of America 12. Auditor 13. city 14. Date
Audit report -Young & Old, CPAs, recently completed a financial statement audit of the Bear Corporation. The following information pertains to the audit: a. Bear is a large publicly-traded company with a June 30 fiscal year end b. The fieldwork for the most recent audit was completed on August 1, 20X3 c. Young & Old is a national accounting firm headquartered in Chicago, IL. The audit of Bear Corp. was completed by the New York, NY office. Young & Old have been Bear's auditors since 1995. d. No unusual or inappropriate items, or items requiring further disclosure, were found during the course of the financial statement audit
1. Independent Registered Public Accounting Firm 2. The shareholders and the Board of Directors of Bear Corp. 3. Opinion on the Financial Statements 4. operations, stockholders equity, and cash flows 5. notes 6. "financial statements" 7. fairly, in all material respects 8. its operations and its cash flows 9. U.S. generally accepted accounting principles 10. Basis for Opinion 11. the Company's management 12. express an opinion on the Company's financial statements based on audits 13. the PCAOB 14. independent 15. the Securities Exchange Commission 16. with the standards of the PCAOB 17. reasonable assurance 18. material misstatement 19. error or fraud 20. risks of the material misstatements 21. error or fraud 22. evidence 23. significant estimates 24. evaluating the overall presentation of the financial statements 25. Auditor 26. How long they have served 27. City 28. Date
You have decided to use monetary unit sampling int he audit of Tide Corp's accounts receivable balance. Few, if any, misstatements or account balance overstatements are expected. Indicate your answers in the shaded spaces provided. Tolerable misstatement: 15,000 Expected misstatement: 6,000 Desired confidence: 95% Recorded balance in A/R: $300,000 Prescribed sample size: 161 Assume that you performed A/R confirmation procedures for the Tide Corporation. Exception were noted in the confirmations of three customers accounts. Those results were entered into audit sampling software, and a UML of $9,928 was calculated
1. What sampling interval should be used to select sample items: 1,863.35 (300,000/161) 2. The auditor selected customer accounts from the accounts receivable subsidiary ledger, and conformations were sent to a total of 155 customer accounts. Explain why the number of confirmation sent is not the sample as sample size shown above. --> 161 indicates the number of dollars, not customer accounts. So more than one dollar could have fallen into on transaction. 3. What is the conclusion about Tide's accounts receivable account balance based on this audit procedure? --> Not materially misstated 4. Explain your basis for this conclusion? UML < TM 5. Will this conclusion result in any modification to the original audit plan? Discuss. --> No, because there are not material misstatements
Firm B: Our firm believes that internal control is extremely important. Therefore, we have adopted an audit approach for all financial statement audits whereby internal control is evaluated carefully and tested thorough for every client. Our firm requires the use of IC questionnaires, detailed flowcharts, and narrative descriptions for every significant transaction area foe very client. Our firm requires a careful evaluation of all systems, including thorough testing of controls in all significant transaction areas. Because we place so much audit effort on controls, we do not perform substantive testing in the areas where we rely on controls.
1. Would you characterize this approach as a heavily reliance or heavily substantive strategy? -heavily reliance strategy 2. What aspect of this firm's approach is a violation of auditing standards? -"we do not perform substantive testing" still need to perform some testing when understanding controls 3. Assume that the firm makes minor modifications to the audit approach to remove the issue that you identified in #2. For what type of portfolio of audit clients is this MODIFIED approach likely to work best? -large clients=heavy reliance 4. Assume that the firm makes minor modifications to the audit approach to remove the issue that you identified in #2. For what type of portfolio of audit clients is this MODIFIED approach likely to be inefficient? -small equals NOT reliance
Firm A: We have noted in the past that several of our financial statement audit clients do not have strong internal control. Therefore, in order to keep our audit approach consistent from client to client, we have decided to adopt an approach whereby we completely ignore internal control in all financial statement audits. We concentrate our audit effort entirely on performing extensive tests of account balances.
1. Would you characterize this approach as a heavily reliance or heavily substantive strategy? -heavily substantive strategy 2. What aspect of this firm's approach is a violation of auditing standards? -completely ignoring internal control in all financial statement audits. must obtain an understanding of internal control 3. Assume that the firm makes minor modifications to the audit approach to remove the issue that you identified in #2. For what type of portfolio of audit clients is this MODIFIED approach likely to work best? -heavy substantive strategy= small 4. Assume that the firm makes minor modifications to the audit approach to remove the issue that you identified in #2. For what type of portfolio of audit clients is this MODIFIED approach likely to be inefficient? -reliance strategy= large
FACTS: Buyer Corp. planned to purchase some of the assets of Target Corp. A condition of the purchase was that Target would provide audited 12/31 financial statements to Buyer, so that Buyer could verify Target's financial condition. Target retained Auditor & Co., CPAs to perform this audit, and later informed Auditor that Buyer would be using the financial statements in conjunction with the decision to purchase some of Target's assets. Auditor performed the audit and expressed an unqualified opinion on Target's financial statements. Auditor furnished its audit report to Target in early February, and also sent a copy to Buyer at Target's request. Unknown to Auditor, Buyer required outside financing to complete the acquisition, and furnished a copy of Target's audited financial statements, with Auditor's opinion, to BankCorp. BankCorp granted a $1 million loan to Buyer in March, and Buyer completed the purchase of Target for $1.5 million. BankCorp subsequently split Buyer's loan, packaged a portion of it with some other loans, and sold the package to Securitization Group. Securitization Group sold securities backed by the Buyer loan to John Consumer in June. 1. Standing to Sue for Ordinary Negligence? ADDITIONAL INFO: Shortly after the completion of the Target purchase, Buyer began having financial difficulties as a result of its inability to collect significant accounts receivable that had been acquired from Target, and Buyer defaulted on the loan. As it turns out, there were material misstatements contained in Target Corp.'s 12/31 financial statements, primarily in the area of accounts receivable. In addition to an inadequate allowance for uncollectible accounts receivable, several customer account balances were overstated as the result of an embezzlement scheme perpetrated by a Target employee during the fiscal year that was audited. 2. Standing to sue for Fraud and Constructive Fraud? 3. Who is likely to win (additional facts) a. Assume the following additional facts about the case: In the course of performing the audit, Auditor used sampling in conformity with GAAS and AICPA guidelines to confirm accounts receivable. None of the confirmation evidence gathered suggested overstatement of the confirmed customer account balances, and Auditor concluded that the accounts receivable balance was not materially misstated. The testing of the allowance for uncollectibles was also consistent with what could be reasonably expected of an auditor on this type of engagement. 4. Ignore the information from part a, and assume the following facts instead: While performing the audit, Auditor discovered that Target's bookkeeper had embezzled $500. Auditor had some evidence that additional embezzlement's were possible. Auditor decided that $500 was not material to the financial statements, and decided that the other possible embezzlement's did not require further investigation. Auditor did not discuss the detected embezzlement with Target's management. Unknown to Auditor, the bookkeeper had in fact embezzled significant sums of cash from Target, and in conjunction with these embezzlement's, the accounts receivable balance was materially overstated. Additionally, Auditor did not follow the audit program when auditing the allowance for uncollectible accounts receivable, and as a result, failed to perform a necessary audit procedure that would have indicated that the allowance was in fact understated.
1. a. Assume the jurisdiction for this case follows the Ultramares (strict privity) doctrine. Which parties have standing to due Auditor for ordinary negligence? -Target corp. because you must be directly involved (named in the engagement letter) b. Assume the jurisdiction for this case follows the Credit Alliance (Near privity/known 3rd parties) guidance. Which parties have standing to sue Auditor for ordinary negligence? -Buyer Corp and Target Corp. because they are known third parties c. Assume the jurisdiction for this case follows the Restatement of Torts (Foreseen 3rd parties) guidance. Which parties have standing to sue Auditor for ordinary negligence? -Buyer corp and Target corp d. Assume the jurisdiction for this case follows the Rosenblum (Rosenblum foreseeable 3rd parties) guidance. Which parties have standing to sue Auditor for ordinary negligence? -Buyer Corp, Bank, and Target Corp (reasonable when doing acquisition, go to bank for loan) (maybe securitization group and John consumer --> would depend on specific judge received in case because some may say yes reasonable loan sell off portfolios) 2. a. If there is reason to believe that there may have been fraud involved, which parties would have standing to sue Auditor for fraud? -Buyer Corp., Bank, and Target Corp b. Which parties would have standing to sue Auditor for gross negligence/constructive fraud? -Buyer Corp., Bank, and Target Corp 3. a. Based on these facts, if a plaintiff who suffered a loss sues Auditor on the ground of Fraud, who will win? -Auditor --> didn't have any knowledge or intent of the fraud and false information, nothing came to attention of auditor that receivables were misstated b. Based on these facts, if a plaintiff who suffered a loss sues Auditor on the ground of gross negligence/constructive fraud, who will win? -Auditor --> testing was consistent with reasonably expected from the auditor *no indication auditor acted recklessly* c. Based on these facts, if a plaintiff who suffered a loss and has appropriate standing sues Auditor on the ground of ordinary negligence, who will win? -Auditor --> performed audit in accordance with professional standards and used due care 4.a. Based on these facts, if a plaintiff who suffered a loss sues Auditor on the ground of fraud, who will win? -Auditor --> didn't have knowledge of materiality amount b. Based on these facts, if a plaintiff who suffered a loss sues Auditor on the ground of Gross negligence/constructive fraud, who will win? -Plaintiff --> auditor had knowledge and chose to ignore the signs to dig further c. Based on these facts, if a plaintiff who suffered a loss and has appropriate standing sues Auditor on the ground of ordinary negligence, who will will? -Plaintiff--> auditor failed to follow audit program which breaches duty of due care
Threats to independence
1. adverse interest (member and attest clients are suring each other) 2. advocacy (member serves as "expert witness" for an attest client) 3. familiarity (simultaneous employment with client, member of attest engagement team has immediate family member or close relative or close friend who works in a key position for an attest client, partner serves on engagement team for prolonged period) 4. management participation (serving as an officer or director of attest client, designing or maintaining internal controls of attest client, making hiring decisions for attest client) 5. self-review (auditing your own work) 6. undue influence (client management threatens to switch auditors, pressure to reduce audit procedures to reduce the audit fee) 7. self-interest (any direct financial interest in attest client, material indirect financial interest, firm relies heavily on revenue from a single attest client, material joint business venture with an attest client, unpaid fees from a past engagement_ **if a partner or professional employee leaves the firm and is subsequently employed by a client in a KEY POSITION, a number of conditions must be met** even if seeking or discussing potential employment is deemed to impair independence unless certain measures are taken, including removal from the engagement
Nine categories of prohibited non-audit services for audit clients
1. bookkeeping 2. financial information systems design and implementation 3. appraisal or valuation services 4. actuarial services 5. internal auditing outsourcing services 6. management functions or human resources 7. broker or dealer 8. legal services 9. expert services Tax services are still allowed for audit clients under the SEC rule PCAOB rules disallow the following tax services for audit clients 1. aggressive interpretations of tax laws and regulations 2. personal tax services to client management in financial reporting oversight roles
In a test of controls, the only 2 possible conclusions are
1. controls are effective enough to support planned reliance --> rely as planned 2. controls are not effective enough to support planned reliance --> do not rely you can not make a judgment about an account balance by performing a test of controls statistical decision rule: compare CUDR to TDR non-statistical decision rule: look at SDR in relation to EDR and TDR and see where it falls in that range
Possible errors of book-to-physical difference (perpetual systems)
1. cutoff errors 2. theft --> stole items from inventory 3. unreported scrap or breakage *client will make adjusting journal entry
Steps in attribute sampling: Evaluation
1. determine sample deviation rate (SDR) -e.g. if the auditor discovers 2 deviations in a sample of 50, the SDR is 4% 2. Calculate Computed Upper Deviation Rate (CUDR) -CUDR= SDR+ an allowance for sampling risk -can be calculated using statistical tables or software 3. Decision Rule: Compare CUDR to Tolerable -as long as CUDR does not exceed tolerable, the test supports planned reliance on the control -if CUDR > Tolerable, the test does not support planned reliance on the control
Sampling in Tests of Balances: The Big Picture
1. identify an account balance to be tested. Since there are likely to be some misstatements in any account, identify the amount of misstatement you expect to find in the account. 2. Identify the maximum amount of misstatement that you could tolerate and still feel that the balance is not materially misstated 3. Select a sample of items from the account balance. Identify the amount of misstatement in the sample. Use the sample information to come up with an estimate of misstatement for overall account balance 4. Evaluate results. Determine whether the balance is fairly stated (i.e. not materially misstated) -YES: No need for additional testing beyond what was initially planned -NO: May require additional testing, client adjustment, or possibly qualified or adverse opinion
Assessing control risk
1. identify specific controls that you plan to rely on 2. perform tests of those controls 3. based on results, conclude on the achieved level of control risk -continue with reliance strategy OR switch to substantive strategy Test thru a combination of -inquiry -inspection -observation -reperformance
Procedures for Obtaining Audit Evidence
1. inspection of documents or records 2. inspection of tangible assets 3. observation 4. inquiry 5. confirmation 6. recalculation (math accuracy) 7. reperformance (executing a process or control) 8. scanning (a specific type of inspection of records) 9. analytical procedures
A plaintiff is suing an auditor under the section 10(b) provisions of the 1934 Act. What elements must be proven by the plaintiff?
1. material factual omission or misrepresentation 2. reliance by the plaintiff on the F/S 3. damages suffered by plaintiff as a result of reliance 4. scienter
Auditor concerns during the observation of the client's physical inventory count
1. movement of goods during the count 2. client count teams and instructions 3. use of inventory tags/count sheets; tag control information 4. test counts-record in work papers 5. cut-off information (last shipper and receiving report) 6. obsolescence/slow moving inventory 7. consignments, bill and hold
Baker Corp. engaged Auditor & Co. to audit its 12/31/08 financial statements. Auditor was advised that these financial statements were to be included in the registration statement for the initial public offering of Baker Corp's stock. During the audit, Auditor discovered some discrepancies between the client's inventory counts and their own audit test counts. However, they did not follow up or investigate these discrepancies, because the dollar amounts, while significant, were not deemed to be material, and with the deadline for the IPO quickly approaching, they did not want any delays in issuing the report. Auditor issued an unqualified opinion on the 12/31/08 financial statements that were included in the S-1. Auditor subsequently audited Baker's 12/31/09 financial statements. During the audit of the 2009 financials, Auditor became aware of an inventory fraud scheme that was being perpetrated by several employees of Baker. Auditor realized that this fraud scheme probably explained the inventory discrepancies in the prior year, and noted that similar discrepancies existed in the current year inventory counts. After further investigation, Auditor determined that inventory was materially misstated at 12/31/09, and likely was materially misstated at 12/31/08. Baker's CEO assured Auditor that these issues would be addressed internally, and that going forward the inventory balances would be fairly stated, but there was no way to make the correction in the current year without a huge impact on the financial statements. Because Auditor did not want to call attention to the prior year misstatements, an unqualified opinion was also issued for the 12/31/09 statements, which were included, along with the 12/31/08 statements, in Baker's fiscal 2009 10-K. In July 2010, it became public knowledge that employees of Baker had been perpetrating an inventory fraud since at least early 2008, and as a result, inventory was in fact materially misstated on the 2008 and 2009 balance sheets. This news caused an immediate negative market reaction, a decline in the price of Baker's stock down to about $3 per share, and the price has not rebounded. Because of the fragile financial health of Baker and its inability to raise capital at this point, it is anticipated that Baker will file for bankruptcy protection in the near future. The following individuals are considering suing Auditor under the protection of the 1933 Act. Analyze the likelihood of a successful suit. Be sure to analyze each of the necessary elements. 1. Buyer A: Purchased 1,000 shares of Baker stock during the IPO at $20 per share, and sold those shares a few days later for $23 per share. 2. Buyer B, who purchased 1,000 shares of Baker stock during the IPO at $20 per share, and just sold them for $3 per share. The following individual is considering suing Auditor under the protection of the 1933 and 1934 Acts. Analyze the likelihood of a successful suit. Be sure to analyze each of the necessary elements. 3. Buyer C, who purchased 1,000 shares of Baker stock in May 2010 at a price of $22 per share, and just sold them for $3 per share.
1. no likelihood (1/2 elements met) -loss suffered -NO (sold for $3 gain per share) -material misstatement 2. likelihood of successful suit -loss suffered - YES -knowledge of material misstatement present *unlikely auditor can show his due diligence* 3.Under 33 --> unlikely because not under IPO purchase Under 34 --> likely to win 1. loss suffered 2. material misrepresentation present 3. evidence of auditor intent to deceive (fraud) 4. reliance --> not clear
Ways the financial statements could fail to be "correct"
1. omit something that should be included 2. include something that does not belong (fictitious or not legitimate) 3. include items that belong to someone else 4. items are not adequately presented or disclosed in accordance with GAAP 5. include items in the wrong period, at the wrong dollar amount, or using the wrong valuation
Special reporting issues
1. reports on comparative financial statements 2. other information in documents contained audited financial statements 3. special reports
Basic categories of activities in completion phase
1. review for contingent liabilities; legal letters 2. review for commitments 3. review for subsequent events/subsequent discovery of facts 4. final evaluation of evidence 5. communicate with those charged with governance
In preparing the personal tax return for a client, Phyllis Allen, CPA, observed that the deductions claimed for contributions seemed unusually large. The client was unable to provide any documentation to substantiate the deductions, but told Phyllis with a wink, "Trust me, they are all legitimate." Phyllis completed the return based on the information originally provided by the client, with no further investigation, even though she was uneasy about the legitimacy of deductions.
1.300 General Standards Accounting Principles Rule Phyllis was unable to view documentation that supported the numbers she was analyzing, but shall signed the representation letter. VIOLATION 1.100 Integrity and Objectivity Rule --> knowingly misstated facts or subordinate judgment
An auditor used attribute sampling to test a client control. Based on the auditor's initial assessment of control risk (moderate), the auditor plans to place moderate reliance on the control, and also perform a moderate amount of substantive testing of related accounts. The following information about sampling procedure is available: sample size: 50 deviations found: 1 tolerable deviation rate: 6% expected deviation rate: 4% allowance for sampling risk: 3%
1. sample deviation rate: 2% (1/50) 2. computed upper deviation rate: 5% 3. based on the above, what conclusion should the auditor make about relying on the client's control, and why? --> they can rely on internal controls CUDR < Tolerable 4. What impact will this have on the audit plan? --> no modifications to the planned substantive procedures are necessary
Circumstances for audit opinions other than "unqualified"
1. scope limitation- material but not pervasive --> qualified "except for" 2. scope limitation - pervasive --> disclaimer (no opinion) 3. GAAP departure- material but not pervasive --> qualified "except for" 4. GAAP departure - pervasive --> adverse 5. auditor not independent --> disclaimer (no opinion)
Applying materiality to the audit
1. set preliminary judgment about materiality for overall financial statements (planning materiality) 2. determine materiality for individual accounts (tolerable misstatement or performance materiality 3 document known misstatements and likely misstatements based on audit work, compare aggregated misstatement to PM aggregated misstatements < planning materiality indicates that amounts are not materially misstated
A plaintiff is suing an auditor for ordinary negligence in conducting a financial statement audit. What four elements must be proven by the plaintiff?
1. the auditor had a duty of care to the plaintiff 2. the auditor breached the duty of care 3. the third party suffered an actual loss 4. there is a direct casual connection between the auditor's negligence and the plaintiff's injurt
General Types of Analytical Procedures
1. trend analysis -examine changes over time -generally used in preliminary analytical procedures 2. ratio analysis -relationships (between accounts or to non-financial data) compared over time or to benchmarks -generally used in preliminary analytical procedures -common size financial statements 3. reasonableness test -develop an expectation (using financial and non-financial data) and use it to test recorded account balances -commonly used in substantive procedures
In a test of balances, the 2 possible conclusions are
1. unacceptably high risk that balance is materiality misstated 2. balances is fairly stated/not materially misstated you can not make a judgment about controls by performing a test of balance statistical decision rule --> compare UML to tolerable misstatement non-statistical decision rule --> look at projected misstatement in relation to EM and TM and see where it falls in that range
John Johnson conducted a test of controls with the following information: -tolerable deviation rate: 6% -expected population deviation rate: 2.5% -sample size: 150 -deviations found: 5 -computed upper deviation rate: 6.9%
1. what is the amount of allowance for sampling risk that is being incorporated into the auditor's final results? -allowance from sampling risk = 3.57% 2. continue the remainder of the audit as originally planned, with no modifications to control risk or planned substantive procedures -no, CUDR is greater than TDR indicating the audit should not continue 3. Increase the assessment of control risk and modify other planned audit procedures -yes, allow for substantive testing to be done 4. decrease the assessment of control risk and modify other planned audit procedures -no, control risk is already lower than it should be so decreasing risk doesn't make sense
Rankin, CPA, provides tax services, management advisory services, and bookkeeping services and conducts audits for JeffCo, a small, nonpublic company with a small staff. Rankin's bookkeeping services consist of posting client-prepared entries, as directed by the client. JeffCo's controller prepares all entries and is responsible for making all decisions about the content of the entries. In no case does Rankin make management decisions for JeffCo.
1.200 Independence Rule CPA is allowed to provide advice but not allowed to participate in management and make decisions that could strongly influence. NOT a violation 1.600 Advertising --> cannot be misleading
John Brown is a CPA who has been employed as a staff accountant by Lyle and Lyle, CPAs, for 3 years. John owns 25 shares of stock in Cooper corporation, an audit client of firm that currently has 2 million shares of common stock outstanding. John does not work on that audit engagement. The amount of stock is not material to his personal wealth.
1.200 Independence Rule Covered members are not allowed to have a direct financial interest in an attest client. NOT a violation because John is not a covered member
Relevant assertion
A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated.
Hank Tacks, CPA, does not perform attest services. His tax client, Able Industries, needed to have some attest services performed, and asked Hank to recommend a CPA firm. Hank referred Able to Variety, CPAs. Variety has an agreement with Hank whereby Variety will pay Hank a 10% referral fee on any revenues they earn from Able. Hank has not disclosed this fee arrangement to Able.
1.500 Fees Commissions and Referral Fees Rule Referral fees are allowed to all clients as long as they are disclosed to the client. VIOLATION because Hank did not disclose information to Able, his client
Due professional care
A legal standard requiring that the auditor perform his or her professional services with the same degree of skill, knowledge, and judgment possessed by other members of the profession.
Control Deficiency
AS 2201 definition -a control deficiency exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned functions, to prevent or detect misstatements on a timely basis Design deficiency: control is missing; or an existing control is not designed properly to achieve the intended result Operation deficiency: a properly designed control does not operate as designed, or the operator does not perform the control effectively
Material Weakness
AS 2201 definition -a deficiency or combination of deficiencies in ICFR, such that there is a reasonable possibility that a material misstatement in the company's financial statements will not be prevented or detected on a timely basis probably= likely to occur reasonably possible= more than a remote likelihood
Planning an audit strategy
AR = IR*CR*DR Lower assessment of CR (some planned reliance) requires testing of controls in order to rely on them CR set at maximum indicates no planned reliance on controls. Instead of extensive control testing, the auditor substitutes more substantive testing.
Audit risk model
AR= IR * CR * DR Inherent risk: susceptibility of an assertion or balance to material misstatement, assuming there are no related internal controls Control risk: risk that a material misstatement could occur and not be prevented or detected by internal controls Detection risk: risk that the auditor will not detect a material misstatement in an assertion or balance
Which auditing standard provides the guidance (effective for audits of calendar year 2020 financial statements) for auditing a public company client's accounting estimate?
AS 2501: Auditing Accounting Estimates
Where can similar guidance applicable to the audits of nonpublic companies be found (AU-C section number and paragraph)?
AU-C Section 540: Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures
A primary advantage of using generalized audit software packages to the audit financial statements of an entity that uses an IT system is that the auditor may a. consider increasing the use of substantive tests of transactions in place of analytical procedures b. substantiate the accuracy of data through self-checking digits and hash totals c. reduce the level of required tests of controls to a relatively small amount d. access information stored on computer files while having a limited understanding of the entity's hardware and software features
Access information stored on computer files while having a limited understanding of the entity's hardware and software features
Generally accepted accounting principles (GAAP)
Accounting principles that are generally accepted for the preparation of financial statements in the United States. GAAP standards are currently issued primarily by the FASB, with oversight and influence by the SEC. International Financial Reporting Standards (IFRS) are set by the International Accounting Standards Board.
Jan Jett, CPA, formerly worked for Delta Disk Drive. She is currently interviewing for a position with MaxiScribe, a competitor. She has agreed to provide confidential information about Delta's trade secrets if she receives the job. 2.400
Acts Discreditable Rule -Interpretation about information gathered during course of employment can't be shared without employer consent -Jett's providing confidential information obtained from her employer without consent
Which of the following legal situations would be considered to impair the auditor's independence? a. An expressed intention by the present management to commence litigation against the auditor, alleging deficiencies in audit work for the entity, although the auditor considers that there is only a remote possibility that such a a claim will be filed. b. Actual litigation by the auditor against the entity for an amount not material to the auditor or to the financial statements of the entity arising out of disputes as to billings for management advisory services. c. Actual litigation by the auditor against the present management, alleging management fraud or deceit. d. Actual litigation by the entity against the auditor for an amount not material to the auditor or to the financial statements of the entity arising out of a dispute as to billings for tax services.
Actual litigation by the auditor against the present management, alleging management fraud or deceit
For the following, determine which type of opinion on ICFR as of 12/31/X1 should be given by the external auditor. Able Corp's auditors found a material misstatement in the company's 12/31/X1 revenue account balance during their audit field work in January. The misstatement was brought to management's attention and was adjusted. Additionally, management immediately implemented some new controls over revenue in this area. Both management and the company's internal audit department tested the new controls and found them to be effective. Management has assured the auditors that this type of misstatement is not longer possible given the new controls in place.
Adverse opinion- ICFR -did not change misstatement before year-end -financial statements can be fixed so that an unqualified opinion can be rendered
Audit evidence
All the information used by the auditor in arriving at the conclusions on which the audit opinion is based. Audit evidence includes the information contained in the accounting records underlying the financial statements, as well as other information.
Internal audit function
An independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.
Internal auditing
An independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.
Financial interest
An ownership interest in an equity or a debt security issued by an entity, including rights and obligations to acquire such an interest and derivatives directly related to such interest. A direct financial interest is a financial interest that is owned directly by an individual or entity, or is under the control of an individual or entity. An indirect financial interest is a financial interest that is beneficially owned through an investment vehicle, estate, trust, or other intermediary when the beneficiary does not control the intermediary or have authority to supervise or participate in the intermediary's investment decisions
An auditor is performing substantive procedures of pricing and extensions of perpetual inventory balances consisting of a large number of items. Past experience indicates that there may be numerous pricing and extension errors. Which of the following statistical sampling approaches is most appropriate? a. classical variables sampling b. monetary-unit sampling c. stop-n-go sampling d. attribute sampling
Classical variables sampling
For each misstatement which control activity, assertion, and suggested control are appropriate? After the physical count of inventory, it was noted that one counter's tickets contained several cases where the wrong product description or wrong quantity was written down.
Control activity: Performance reviews Assertion: VA-Accuracy Suggested Control: someone needs to check work
Which control activity, assertion, and test are appropriate for this control? The payroll system calculates gross and net pay based on hours worked and approved employee pay rate. Payroll personnel periodically check the hours, rates, and calculations on a test basis, and initial the records that they have reviewed.
Control activity: Performance reviews Assertion: VA-Accuracy or authorization Test: observe doing review, inspect documents for initial, then actually re-perform review
For each misstatement which control activity, assertion, and suggested control are appropriate? A vendor's invoice was paid twice for the same shipment. The second payment arose because the vendor sent a duplicate copy of the invoice two weeks after the original, and both were paid by Fresh Foods.
Control activity: information processing - application Assertion: occurrence Suggested control: control that flags invoice numbers to see if already paid
Control deficiency communication of internal control-related matters
Control deficiency -exists when the design or operation of a control does not allow management or employees, in the normal course of performing their assigned function, to prevent, or detect and correct, misstatements on a timely basis
An auditor should request that an audited entity send a letter of inquiry to those attorneys who have been consulted concerning litigation, claims, or assessments. The primary reason for this request is to provide a. the opinion of a specialist as to whether loss contingencies are possible, probable, or remote b. a description of litigation, claims, and assessments that have a reasonable possibility of unfavorable outcome c. an objective appraisal of management's policies and procedures adopted for identifying and evaluating legal matters d. corroboration of the information furnished by management concerning litigation, claims, and assessments
Corroboration of the information furnished by management concerning litigation, claims, and assessments
In your audit of Appleton Industries for 20X1, you found a number of matters that you believe represent necessary adjustments to the company's books in order to comply with GAAP. Planning materiality for the engagement was initially $75,000 (which was based on 5% of expected income before taxes, calculated at the time of planning). Actual 20X1 income before taxes (prior to any adjustments) is $1,200,867. Your review and testing of the allowance for uncollectible accounts indicates that is is understated by approximately $45,000 *may be hardest to make them adjust
DR Bad Debt Expense CR Allowance for Doubtful Accounts Adjustment dollar amount: $45,000 Effect on total assets: decrease of $45,000 Effect on total liabilities: N/A Effect on S/E: N/A Effect on total revenue: N/A Effect on total expenses: increase of $45,000 Effect on net income: decrease of $45,000
In your audit of Appleton Industries for 20X1, you found a number of matters that you believe represent necessary adjustments to the company's books in order to comply with GAAP. Planning materiality for the engagement was initially $75,000 (which was based on 5% of expected income before taxes, calculated at the time of planning). Actual 20X1 income before taxes (prior to any adjustments) is $1,200,867. Inventory cut-off tests indicates that $22,357 of inventory received on December 30, 20X1 was recorded as a purchase on account in January 20X2. These items were included in the inventory physical count, and therefore are included in the ending inventory balance. The related closing entries for purchase have already been made. *purchases is already closed, inventory properly included
DR COGS CR AP Adjustment to dollar amount: $22,357 Effect on total assets: N/A Effect on total liabilities: increase by $22,357 Effect on S/E: N/A Effect on total revenue: N/A Effect on total expenses: increase by $22,357 Effect on net income: decrease by $22,357
Beginning inventory: 500 Net purchases: 800 (understated by 70) Goods available for sale: 1300 (understated by 70) Ending inventory physical count: 700 (understated by 70) COGS: 600 Assume it is discovered that a cut-off error occurred, whereby a purchase of $70 that pertains to 20X1 was not recorded as a purchase until 20X2, an the units of inventory from that purchase were improperly excluded from the physical count. What adjusting entry is necessary to correct this error?
DR Inventory 70 CR Accounts Payable 70
Example for periodic inventory system: Beginning inventory: 500 Purchases: 800 Ending inventory per physical count: 700
DR Inventory 700 CR Inventory 500 DR COGS 600 CR Purchases 800
In your audit of Appleton Industries for 20X1, you found a number of matters that you believe represent necessary adjustments to the company's books in order to comply with GAAP. Planning materiality for the engagement was initially $75,000 (which was based on 5% of expected income before taxes, calculated at the time of planning). Actual 20X1 income before taxes (prior to any adjustments) is $1,200,867. Inventory cut-off tests also indicate several sales invoices on account totaling $36,022 recorded in the 20X1 sales journal for goods that were not shipped until early 20X2. The items, which had a cost of $19,000 were set aside and therefore were not included in the physical inventory count *recorded a sale that did not happen, so undo COGS, COGS aren't still in inventory
DR Sales CR AR Adjustment dollar amount: $36,022 Effect on total assets: decrease of $36,022 Effect on total liabilities: N/A Effect on S/E: N/A Effect on total revenue: decrease of $36,022 Effect on total expenses: N/A Effect on net income: decrease of $36,022 DR Inventory CR COGS Adjustment dollar amount: $19,000 Effect on total assets: increase of $19,000 Effect on total liabilities: N/A Effect on S/E: N/A Effect on total revenue: N/A Effect on total expenses: decrease of $19,000 Effect on net income: increase of $19,000
For the following, determine which type of opinion on ICFR as of 12/31/X1 should be given by the external auditor. Rodriguez and Co. engaged their external auditors after the company's fiscal year end. Because of time constraints, the auditor was unable to perform a full audit of ICFR. The evidence was collected suggests that controls are strong, and the auditor doubts that any material weaknesses would have been detected if a full audit have been possible.
Disclaimer of opinion -must have sufficient and appropriateness evidence to conclude effectiveness of internal controls
Establishing an Understanding with the Client
Engagement Letter -formalizes terms and minimizes misunderstanding -required to be in writing Use of Internal Audit Work -decide whether and how much to use, after considering relevance, competence and objectivity -make arrangements with the client for access Audit committee -required for public companies; must be independent -auditor reports directly to audit committee -pre-approves all audit and non-audit services -auditor is required to communicate certain findings to audit committee
General risk defintions
Engagement risk -an auditor's exposure to financial loss and/or damage to professional reputation simply from being involved in an engagement (e.g. lawsuits, negative publicity) -managed through careful client acceptance Audit risk -risk that an auditor will unknowingly issue an inappropriate opinion on materially misstated F/S -two factors 1. risk that a material misstatement exists and 2. risk that the auditor fails to detect it -can be managed through the audit risk model and the nature, timing, and extent of audit procedures performed for each assertion or transaction class
A tax client engaged in J. Bacon, CPA to assist the installation of a computer network. Bacon has no experience in this type of work and no knowledge of the client's system, so Bacon engaged a computer consulting firm to perform the work for him. The consultant is not in the practice of public accounting, but Bacon knows he has a good reputation. Because of the highly technical nature of the work, and Bacon's lack of familiarity with it, Bacon is not able to review the consultant's work. 1.300
General Standards Rule -professional competence *violation that he can't review consultant's work because he has the inability to review consultants work is an indication he should not be taking part in this engagement*
General Standards (1.300 and 2.300)
General Standards Rule 1. Professional competence- undertake only those professional services that the member or firm can expect to complete with professional competence (conducting additional research or consulting with other professionals to obtain additional knowledge is OK, BUT must have enough knowledge and expertise to be able to supervise a specialist and evaluate his/her own work;otherwise, refer to the work of someone else) 2. Due professional care- when performing professional services 3. Planning and supervision - of professional services 4. Sufficient relevant data - to afford reasonable basis for conclusions Compliance with Standards Rule -must comply with professional standards when performing any professional services Accounting Principles Rule -If financial statements contain a material GAAP departure, do not 1. state or express an opinion that financial statements comply with GAAP or 2. state no need for material modifications in order to comply with GAAP unless unusual circumstances would make GAAP compliance misleading *knowingly signing a false representation letter violates this rule*
Format of audit documentation
Heading -client name -title of the working paper -client's year-end date Indexing and cross-referencing -notations that provide a trail from financial statements to audit documents, and between work papers Tick marks -notations made next to work paper items indicating auditor/reviewer actions
Which of the following would be considered a non attest assurance service engagement I. Expressing an opinion about reliability of an entity's financial statements II. Reporting that a company's sustainability metrics are complete and accurate a. I only b. II only c. Both I and II d. Neither I or II
II only
Integrity and Objectivity Rule (1.100 and 2.100)
In the performance of any professional service, a member: 1. shall maintain objectivity and integrity 2. shall be free of conflicts of interest 3. shall not knowingly misrepresent facts or subordinate his or her judgment to others Interpretations cover the following areas: 1.110 conflicts of interest 1.120 gifts and entertainment 1.130 preparing and reporting information 1.140 client advocacy 1.150 use of 3rd party service provider 2.110 conflicts of interest 2.120 gifts and entertainment 2.130 preparing and reporting information *** 2.160 educational services *** includes lying to or hiding information from the external auditor
Assurance services
Independent professional services that improve the quality of information, or its context, for decision makers. Encompasses attest services and financial statement audits.
Audits of Non-Public Companies
Issued by: The AICPA's ASB (since 1950s) Guiding framework: 7 principles underlying an audit conducted in accordance with GAAS Body of standards: "Auditing Standards Generally Accepted in the U.S." OR "Generally Accepted Auditing Standards" (GAAS) Individual Standards: Clarified Statements on Auditing Standards (SAS) Numbering System: Chronological: By SAS numbers, Topical: By AU-C section numbers
Known misstatement vs. Likely misstatement
KNOWN: a factual misstatement that the auditor is able to verify with certainty -e.g. based on results of A/R confirmation procedures, auditor determines that a customer account is overstated by $5,000 as the result of a cutoff error whereby $5,000 of merchandise that was shipped in January 20X2 of recorded as a sale on account in December 20X1 LIKELY: can not be verified with certainty, but auditor has evidence suggesting the existence of misstatement -e.g. projection of sampling results indicates that in addition to the $10,000 of misstatements found in the sample, there is a statistical likelihood that another $35,000 of misstatements exist in the rest of the population -e.g. difference between auditor's estimate vs. client's estimate of the Allowance for doubtful accounts
Significant SOX provisions affecting corporate governance
Management -CEO and CFO must certify the financial statements -companies must provide a comprehensive report on internal controls over financial reporting Audit Committees -given expanded powers as the audit client and must pre-approve any non-audit services by its external auditors -must be comprised of outside (independent) members -must disclose whether they have a financial report -must report their activities to the public Auditors -must audit and report on internal controls -5th year rotation for engagement partners -a "cooling off" period before an audit team member can take a high-level position with an audit client without jeopardizing the independence of the public accounting firm -prohibited from providing certain non-audit services for their own audit clients (can still provide non-audit services to non-audit clients)
Which of the following statements best describes management's and the external auditor's respective levels of responsibility for a public company's financial statements? a. Management and the external auditor share equal responsibility for the fairness of the entity's financial statements in accordance with GAAP b. Neither management nor the external auditor has significant responsibility for the fairness of the entity's financial statements in accordance with GAAP. c. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatements d. Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides a guarantee that the statements are free of material misstatement
Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides reasonable assurance that the statements are free of material misstatements
In a jurisdiction that follows the credit alliance (near privity) doctrine, which third parties have standing to sue an auditor for ordinary negligence?
NAMED third parties + parties whose reliance on the F/S was KNOWN by the auditor
Adams Corp., a major customer of Tracy Corp., filed for bankruptcy on March 30, 20X2 as a result of an uninsured casualty loss in early March that has left the company unable to continue operations. Adams had been a good customer who always paid in a timely manner, and the balance appeared collectible, but the bankruptcy makes it doubtful that Tracy will be able to collect any of the remaining outstanding accounts receivable balance. (not subsequent discovery)
NO ACTION
Important aspects of audit evidence
Nature --> type of info Sufficiency --> quantity Appropriateness --> quality (relevance and reliability) Overall evaluation: -is there sufficient appropriate evidence to support management's assertions? -is the evidence persuasive?
Jason Brand is a Partner in the Dallas office of Old and Older, CPAs. Jason's largest audit client is Abbot Industries, and he is the lead partner on that engagement. Jason is also the partner on the review engagement RevCo's financial statements. Determine whether each of the following scenarios constitutes an independence violation for Jason or for Older and Older. Jason's mother Marie lives with Jason and is his dependent. She owns a small interest in Mutual A (a diversified mutual fund that owns shares of Abbott Industries), that is currently worth approximately $2,000.
No -indirect financial interest but not material *a direct family member*
Jason Brand is a Partner in the Dallas office of Old and Older, CPAs. Jason's largest audit client is Abbot Industries, and he is the lead partner on that engagement. Jason is also the partner on the review engagement RevCo's financial statements. Determine whether each of the following scenarios constitutes an independence violation for Jason or for Older and Older. Jason's dependent son, Doug, recently accepted a full-time internship position as a staff accountant in RevCo's fixed asset department. His primary job responsibility will be to process fixed asset acquisitions.
No -not a key position unless specific firm has more stringent rules
Young and Younger, CPAs have been engaged to perform the audit of ABC Corp. The audit will be performed by the firm's Chicago office. For each of the following scenarios, determine whether the person in question qualifies as a "covered member." John Brew, an audit senior, has been employed by the Chicago office of Young and Younger for 3 years. John has not been assigned to the ABC engagement.
No -not on engagement and not high enough level of management to be considered
Last receiving report number in 2018 was 49,745 1/01 49,746
Not okay because it is larger than 49,745. The item occurred in January but have to look at the shipping terms FOB destination - January FOB Shipping Point- December
Watching the entity's warehouse personnel count the raw materials inventory.
Observation
The auditor is concerned that the 12/31 General Ledger balance of Accounts Receivable is not supported by underlying documentation. Design a test of details of balances that tests the VA-ACCURACY (math and tie-in) for Accounts Receivable
Obtain accounts receivable subsidiary ledger and test mathematical accuracy and tie to general ledger
Example of substantive procedures: test of details of balances
Obtain client's schedule of prepaid insurance. Vouch the premiums and dates of coverage back to original policies. Calculate number of months unexpected, and apply to premium to determine remaining balance. Trace total to GL.
The auditor is concerned that the 12/31 General Ledger balance of Accounts Payable is not supported by underlying documentation Design a test of details of balances that tests the VA-Accuracy (math and tie-in) for Accounts Payable
Obtain listing of A/P schedules for accruals; footing and listing schedules to agree totals to general ledger. Trace selected items from A/P to subsidiary ledgers and vouchers A/R subsidiary ledger as of 12/31. Foot ledger, test to make sure agrees to general ledger
Additional paragraphs in qualified, adverse, or disclaimer report
PCAOB report guidance -no additional headings -additional paragraph within the opinion section, immediately after the first paragraph AICPA report guidance -additional heading and paragraph immediately before opinion section -the heading of the opinion section reflects the type of opinion being given 1. basis for qualified opinion <discusses the scope limitation and quantifies the accounts affected> 2. basis for disclaimer of opinion <discusses the scope limitation and quantifies the accounts affected> 3. basis for qualified opinion <discusses the GAAP departure and quantifies the effects on the financial statements> 4. basis for adverse opinion <discusses the GAAP departure and quantifies the effect on the financial statements>
Additional Paragraphs in "clean" opinion report
PCAOB report guidance: -no additional headings -EXPLANATORY required -additional paragraph added to opinion section 1. reference in the report of other auditors 2. substantial doubt about going-concern assumption 3. change in accounting principle 4. restatement to correct a prior misstatement 5. auditor not required to audit ICFR -no additional headings -EMPHASIS optional -additional paragraph added to opinion section 1.related party transaction 2. material subsequent events 3. matters affecting comparability (but not accounting changes) 4. uncertainty in future outcome of litigation or regulation AICPA report guidance: -emphasis-of-matter 1.to draw the reader's attention to something that s already disclosed in the financial statements (in required situations) -additional heading and paragraph immediately after opinion 1. substantial doubt about going-concern assumption 2. change in accounting principle 3. restatement to correct a prior misstatement 4. change in report entity (in optional situations) -additional heading and paragraph immediately after opinion 1. related party transaction 2. material subsequent events 3. uncertainty in future outcome -other matter -additional heading and paragraph immediately after opinion 1. to inform reader about something that is not already disclosed in the financial statements 2. change in auditor's opinion 3. predecessor auditor report not reissued
Headings specified within the report and ordering
PCAOB report guidance: -opinion on the financial stateemnts (or disclaimer of opinion on the financial statements) -basis for opinion (disclaimer of) opinion -critical audit matters (if applicable) AICPA report guidance -report on the financial statements -management's responsibility for the financial statements -auditor's responsibility -opinion (or qualified opinion or adverse opinion or disclaimer of opinion)
ICFR mentioned in report
PCAOB report guidance: only in opinion on the financial statements section- second paragraph references the audit of ICFR AICPA report guidance: in management's responsibility, in auditor's responsibility section-specifies that no opinion is expressed
Board of Directors
Persons elected by the stockholders of a corporation to oversee management and to direct the affairs of the corporation.
Revenue: design a test of transactions that tests the VA-CUTOFF assertion for sales transactions.
Population: sales journal For a sample of entries in sales journal: Obtain shipping documentation, and verify that the shipping date on the shipping document agrees to the date recorded in the sales journal
The auditor is concerned that shipments of product are being made to customers, but are not being billed to customers (test of transactions) Design a test of transactions that tests the COMPLETENESS of Sales and Accounts Receivable
Population: shipping documents processed during this period Obtain a sample of shipping documents and match to sales invoices generated to that customer. Tie to entry in the sales journal
VA-Classification assertion: a shipment of items in the "sporting goods" product line is recorded as a shipment of "toys"
Pre-established chart of accounts ad people have access to it. transaction --> account number
Financial projections
Prospective financial statements that present, given one or more hypothetical assumptions, an entity's expected financial position, results of operations, and cash flows
Audit strategy: Reliance vs. Substantive
Reliance: rely on the client's controls to prevent misstatement from occurring -TEST those controls to ensure they are worthy of reliance -do considerably less substantive testing of ending balances -Note: must always do some substantive testing in all significant areas Substantive: test the balances directly to gain comfort that the balance is fairly stated -E.g. test the mathematical accuracy of the A/R subsidiary ledger, tie the total to the G/L balance, and send confirmations to verify the legitimacy and accuracy of the component customer account balances -Note: even though control testing is not required, auditor must still obtain an understanding of client's internal controls
Format of Standard Unmodified Opinion (non-public company)
Report on the financial statements -we have audited [identify individual statements, relevant fiscal years, etc...]... and the related notes to the financial statements Management's responsibility for the financial statements -preparation and fair presentations of financial statements -accounting principles generally accepted in U.S.A. (GAAP) -free from material misstatement, whether due to error or fraud Auditor's responsibility -1st: express an opinion based on our audits, auditing standards generally accepted in U.S.A (GAAS), plan and perform, reasonable assurance, free from material misstatement -2nd: (discusses what the audit involves) obtain audit evidence about amounts and disclosures, auditor judgment; RMM whether error or fraud, auditor considers IC to design audit procedures, but not for expressing an opinion on effectiveness of IC, evaluating appropriateness of accounting policies; reasonableness of significant estimates; evaluating overall presentation of financial statements -3rd: evidence is sufficient and appropriate Opinion -in our opinion, financial statements referred to above present fairly, in all material respects -in accordance with accounting principles generally accepted in USA (GAAP)
Is an auditor allowed to not express an opinion
Reporting -yes, must state why and what opinion is rendered
Planning the audit
Risk assessment -identify business risks and other risks that may result in material misstatements Materiality -determine for the overall F/S and at the individual account level Consider multi-location issues Assess the need for specialists -auditor's specialist vs. client's specialist -auditor is ultimately responsible for the work of the specialist Consider possibility of Illegal Acts -Direct effect vs. Indirect effect Identify related parties Perform preliminary analytical procedures -required by auditing standards -to obtain understanding of client's business -to identify accounts/areas where risk of misstatement is higher and more audit effort may be needed Develop an document overall audit strategy, audit plan, and audit program
Fritz Corporation, whose shares are publicly traded, engaged Hay Associates, CPAs, to audit its financial statements. Hay gave an unqualified opinion, despite knowing that the financial statements contained misstatements. Hay's opinion was included in Fritz's Form 10-K filed with the Securities and Exchange Commission. Samson purchased shares and suffered a loss when the stock declined in value after the misstatements became known. In a suit against Hay under the anti fraud provisions of Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934, Samson must prove all of the following except that: a. Samson was a foreseen user of the financial statements b. Samson suffered a loss as a result of reliance on the financial statements c. the stock purchase involved a national securities exchange d. Hay acted with intent to deceive
Samson was a foreseen user of the financial statements
Audit procedures
Specific acts performed as the auditor gathers evidence to determine if specific audit objectives are being met.
In your audit of Appleton Industries for 20X1, you found a number of matters that you believe represent necessary adjustments to the company's books in order to comply with GAAP. Planning materiality for the engagement was initially $75,000 (which was based on 5% of expected income before taxes, calculated at the time of planning). Actual 20X1 income before taxes (prior to any adjustments) is $1,200,867.
TOTALS Effect on total assets: ($51,522) OVERSTATED Effect on total liabilities: $22,357 UNDERSTATED Effect on S/E: N/A Effect on total revenue: ($36,022) OVERSTATED Effect on total expenses: $37,857 UNDERSTATED Effect on net income: ($73,879) OVERSTATED
Sampling as a component of the audit (2/2)
Technology will never eliminate the need for auditors to rely on sampling to some degree because: 1. many control processes require human involvement 2. many testing procedures require the auditor to physically inspect an asset 3. in many cases, auditors are required to obtain and evaluate evidence from third parties 4. audit data analytics are only as good as the quality of the underling data and often the completeness, accuracy, and validity of the underlying data need to be tested and sampling can be an effective and efficient technique 5. audit data analytics often identify a large number of potential exceptions that the auditor may test using sampling
Substantive Strategy
The auditor's decision not to rely on the entity's controls and to audit the related financial statement accounts by relying more on substantive procedures.
Reliance Strategy
The auditor's decision to rely on the entity's controls, test those controls, and reduce the direct tests of the financial statement accounts.
scanning
The auditor's exercise of professional judgment to review accounting data to identify significant or unusual items to test.
Reperformance
The auditor's independent execution of procedures or controls that were originally performed as part of the entity's internal control, either manually or through the use of computer-assisted audit techniques.
Disclaimer of opinion
The auditor's indication that no opinion is expressed on the financial statements. The auditor will disclaim an opinion if a pervasive scope limitation arises or if it is determined that the auditor lacks independence.
Adverse Opinion
The auditor's opinion that the financial statements do not present fairly in accordance with generally accepted accounting principles (or other basis of accounting) due to a pervasively material misstatement.
Audit documentation (work papers)
The auditor's principle record of the audit procedures performed, evidence obtained, and conclusions reached Two primary functions 1. to provide support for the audit report 2. to aid in the conduct and supervision of the audit
The Auditor's Report Format
The auditor's report on ICFR can be: -a separate report OR -combined with the report on the financial statements
As a result of sampling procedures applied as tests of controls, an auditor incorrectly assesses control risk lower than appropriate. The most likely explanation for this situation is that a. the deviation rates of both the auditor's sample and the population exceed the tolerable deviation rate b. the deviation rates of both the auditor's sample and the population are less than the tolerable deviation rate c. the deviation rate in the auditor's sample is less than the tolerable deviation rate, but the deviation rate in the population exceeds the tolerable deviation rate d. the deviation rate in the auditor's sample exceeds the tolerable deviation rate, but the deviation rate in the population is less than the tolerable deviation rate
The deviation rate in the auditor's sample is less than the tolerable deviation rate, but the deviation rate in the population exceeds the tolerable deviation rate
Control risk
The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control.
Control risk
The risk that a misstatement that could occur in an assertion about a class of transaction, account balance, or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity's internal control.
Audit risk
The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.
Judgmental misstatements
These are misstatements that arise from the judgments of management concerning accounting estimates that the auditor considers unreasonable or the selection or application of accounting policies that the auditor considers inappropriate.
Audit field work for the audit of Xcalibur Corp's December 31, 20X3 financial statements was completed on February 28, 20X4 by the firm's Chicago office. Xcalibur Corp. is a non-public company. The auditors have determined that the financial statements are fairly stated, and did not note any items needing additional discussion.
Type of opinion: standard unmodified Title: Independent Auditor's Report Headings or Text: 1. Report of Financial Statements --> none 2. Management's responsibility --> none 3. Auditor's responsibility --> none 4. Opinion --> none Auditor information: Able and Baker. Chicago, IL Report date: February 28, 20X4
Audit field work for the audit of Boswell Corp's December 31, 20X3 financial statements was completed on March 1, 20X4 by the firm's Chicago office. Boswell Corp. is a large public company. The auditors determined that the financial statements are not fairly stated in conformity with GAAP, and the departure from GAAP (related to revenue recognition) is pervasive to the financial statements. A material weakness in ICFR was also noted.
Type of opinion: adverse opinion Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements -->In our opinion, because of the effects of the matters discussed in the following paragraph, the financial statements referred to above don't present fairly. 2. Basis for opinion --> no modifications 3. Critical audit matters --> if revenue recognition issue leading to the adverse opinion is considered a CAM, discussed here 4. Additional paragraphs: <in the opinion on the financial statements immediately after opinion paragraph> "The company has recognized..." (remainder of paragraph discusses the revenue recognition issues and quantifies its effect on the financial statements.) Opinion section ends with a paragraph referencing the adverse opinion on ICFR Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. Chicago, IL Report date: March 1, 20X4
Audit field work for the audit of Dickens Corp's December 31, 20X3 financial statements was completed on March 12, 20X4 by the firm's Cleveland office. Dickens Corp. is a large public company. The auditors were not able to perform inventory observation or cut-off procedures at 12/31/X3. The auditors have been unable to perform other procedures to satisfy themselves about whether the inventory and related balances are fairly stated. The potential effect on any adjustments that the auditors might have deemed necessary if they could have applied full audit procedures are pervasive to the financial statements of Dickens.
Type of opinion: disclaimer Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Disclaimer of Opinion on the financial statements --> we were engaged to audit.. As discussed in the following paragraph, because we were not able to observe the physical inventory count and were not able to apply other auditing procedures to satisfy ourselves, we do not express an opinion on these financial statements 2. Basis for disclaimer--> no modifications except to omit the sentence: " our responsibility is to express an opinion" 4. Additional paragraphs: <second paragraph in this section> discusses the scope limitation. Opinion section ends with a paragraph referencing the unqualified opinion on ICFR Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. Cleveland, OH. Report date: March 12, 20X4
Audit field work for the audit of Chase Corp's December 31, 20X3 financial statements was completed on March 12, 20X4 by the firm's St. Louis office. Chase Corp. is a large public company. The auditors determined that the financial statements are fairly stated in conformity with GAAP, except for the company's accounting for inventory. The effects of this departure are material, but not pervasive, to the financial statements. A material weakness in ICFR was noted.
Type of opinion: qualified - GAAP departure Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements --> In our opinion, except for the effect of inappropriate inventory accounting discussed in the following paragraph, the financial statements referred to above present fairly in all material respects. 2. Basis for opinion --> no modifications 3. Critical audit matters --> If the inventory issue is a CAM, discussed here 4. Additional paragraphs: <after the opinion paragraph> "The Company used an in appropriate method to account for its inventory... (remainder of paragraph discusses the inventory GAAP departure and quantifies its effects on the financial statements.) Opinion section ends with a paragraph referencing the adverse opinion on ICFR Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. St. Louis, Missouri. Report date: March 12, 20X4
Audit field work for the audit of Sample Corp's December 31, 20X3 financial statements was completed on February 28, 20X4 by the firm's Chicago office. Sample Corp. is a large public company. The auditors have determined that the financial statements are fairly stated, and did not note any problems or any items needing additional discussion.
Type of opinion: standard unqualified Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements --> no modifications 2. Basis for opinion --> no modifications 3. Critical audit matters --> standard working, no CAMS noted 4. Additional paragraphs: opinion section ends with a paragraph referencing the unqualified opinion on ICFR Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. Chicago, IL Report date: February 28, 20X4
Audit field work for the audit of Acme Corp's December 31, 20X3 financial statements was completed on February 27, 20X4 by the firm's Cleveland office. Acme Corp. is a large public company. The auditor have determined that the financial statements are fairly stated. Due to severe financial deterioration, the auditors have substantial doubt about Acme's ability to continue as a going concern beyond the upcoming year, and Acme's management has included information in Note 14 related to this issue. Two significant deficiencies in ICFR were noted.
Type of opinion: unqualified, explanatory paragraph Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements --> no modifications 2. Basis for opinion --> no modifications 3. Critical audit matters --> if going concern considered a cam, referenced here 4. Additional paragraphs: <in the opinion on financial statements, immediately after the opinion paragraph> "The accompanying financial statements have been prepared assuming that the company will continue as a going concern. As discussed in note 14..." Opinion section ends with a paragraph referencing the unqualified opinion on ICFR (significant deficiency is not material weakness) Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. Cleveland, OH Report date: February 27, 20X4
Audit field work for the audit of Egan Corp's December 31, 20X3 financial statements was completed on February 16, 20X4 by the firm's Chicago office, and the auditors determined that the financial statements are fairly stated. Egan Corp. is a large public company. On February 27, before the financial statements were issued, Egan suffered an uninsured loss of its warehouse facility due to a fire. Egan's management has included Note 20 in the financial statements, in which they discuss the event and magnitude of the loss, but they have not adjusted any of the financial statement balances to reflect this event. Able and Baker performed additional audit procedures specific to the loss. Based on these procedures, they have determined that the information provided in Note 20 is fairly stated.
Type of opinion: unqualified- emphasis paragraph Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements --> no modifications 2. Basis for opinion --> no modifications 3. Critical audit matters --> standard working, no CAMS noted 4. Additional paragraphs: <in the opinion on the financial statements section immediately after opinion paragraph> "As discussed in Note 20..." opinion section ends with a paragraph referencing the unqualified opinion on ICFR Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. Chicago, IL Report date: February 16, 20X4 except for note 20, for which the date is February 27, 20X4.
Audit field work for the audit of Flower's Corp's December 31, 20X3 financial statements was completed on February 16, 20X4 by the firm's St. Louis office. Flower Corp. is a large public company. Flower has a subsidiary (Bud Company) in Texas whose financial statements were audited by Alamo and Crockett, CPAs, an unqualified Texas firm. Able and Baker have satisfied themselves about the independence and competence of Alamo and Crockett, but are unwilling to take complete responsibility for their audit work. Alamo and Crockett issued an unqualified opinion on Bud's financial statements, and Able and Baker did not note any problems or items requiring additional attention in the Flower audit.
Type of opinion: unqualified- modified wording and explanatory paragraph Title: Report of Independent Registered Public Accounting Firm Headings or Text: 1. Opinion on the financial statements --> In our opinion, based on our audit and the report of other auditors 2. Basis for opinion --> we believe that our audit and the report of other auditors provide a reasonableness basis for our opinion 3. Critical audit matters --> standard working, no CAMS noted 4. Additional paragraphs: <in the opinion on the financial statements section, immediately after the opinion paragraph> "We did not audit the financial statements of Bud company, a wholly owned subsidiary..." (quantify the percentage of consolidated total assets and total revenues represented by Bud.) Opinion section ends with a paragraph referencing the unqualified opinion ICFR. Auditor information: Able and Baker, We have served as the Company's auditor since XXXX. St. Louis, Missouri. Report date: February 16, 20X4
1. Preliminary Judgments about Materiality at the overall F/S Level (PM)
Typical quantitative bases for materiality are a percentage of: -total revenues -income before taxes -income from continuing operations -gross profit -total assets or net assets The quantitative amounts may be adjusted lower for qualitative factors such as: -first-year engagement -control weaknesses -management turnover -high fraud risk -misstatements in prior years -debt covenants -operating close to break even, or close to analyst expectations
A public entity changed from the straight-line method to the declining balance method of depreciation for all newly acquired assets. This change has no material effect on the current year's financial statements but is reasonably certain to have a substantial effect in later years. The client's financial statements contain no material misstatements and the auditor concurs that this change is justified. If the change is disclosed in the notes to the financial statements, the auditor should issue a report with a (n) a. "except for," qualified opinion b. adverse opinion c. unqualified opinion d. consistency modification
Unqualified opinion
For the following, determine which type of opinion on ICFR as of 12/31/X1 should be given by the external auditor. During the audit of ICFR for Wood Corp., the auditor noted several internal control deficiencies. The auditor determined that there is a reasonable possibility that any one of them could result in a misstatement that is significant. The odds are extremely low that the deficiencies, individually or taken together, could result in a material misstatement.
Unqualified opinion
For the following, determine which type of opinion on ICFR as of 12/31/X1 should be given by the external auditor. George and Diana Corp's internal audit department identified a material weakness in the company's ICFR. The company corrected this weakness a few months before year-end, and management's assessment found the new controls to be effective. After testing the relevant revised controls, the auditor finds that they are effective, and believes there is adequate evidence that the controls were operating effectively at the client's year end.
Unqualified opinion -operating effectively as of year-end
Expenditures to purchase inventory have been recorded in the inventory account, not in an administrative expense account
Valuation or allocation -Classification
The Allowance for Uncollectible Accounts Receivable is sufficient - therefore, net Accounts Receivable reflects the amount that the company can realistically expect to collect
Valuation or allocation -Valuation/net realizable value
Common test of details for accounts payable and other accounts: obtain listing of accounts payable, test math accuracy, and agree to general ledger (accuracy/tie-in); reconcile accounts payable vendor total to vendor statements (accuracy); perform a purchases cut-off test (cut-off)
Valuation/Allocation
Cash disbursements are recorded on the correct dates
Valuation/Allocation -Cut-off
Jason Brand is a Partner in the Dallas office of Old and Older, CPAs. Jason's largest audit client is Abbot Industries, and he is the lead partner on that engagement. Jason is also the partner on the review engagement RevCo's financial statements. Determine whether each of the following scenarios constitutes an independence violation for Jason or for Older and Older. Jason's dependent daughter, Julie, received 5 shares of Abbott Industries common stock on her 5th birthday. The shares are currently worth approximately $50.
Violation -direct financial interest -immediate family member which is PROHIBITED
Important Issue Related to Documents and Records: Direction of Testing
Vouching -from journal back to source documents [typically tests for OVER statements] Tracing -from source documents to journal [typically tests for UNDER statements]
From a separate financial statement opinion; paragraph referencing ICFR
We also have audited, in accordance with the standards of the PCAOB, Earthwear Clothiers' internal control over financial reporting as of December 31, 2018, based on the criteria established in Internal Control-Integrated Framework Issued in 2013 by the Committee of Sponsoring Organizations of the Treadway Commissions (COSO). Our report on Earthwear's internal control over financial reporting, dated February 15, 2019, expresses an unqualified opinion.
Auditing standards primarily encourage which of the following conversations between the auditor and another party about financial reporting? a. a conversation with those charged with governance to discuss matters pertaining to financial reporting b. a conversation with only management to discuss matters pertaining to financial reporting c. a conversation with the head of the entity's internal audit department and those charged with governance to discuss matters pertaining to financial reporting d. a conversation in which those charged with governance report on management's views on matters pertaining to financial reporting
a conversation with those charged with governance to discuss matters pertaining to financial reporting
When reporting on comparative financial statements, which of the following circumstances should ordinarily cause the auditor to change the previously issued opinion on the prior year's financial statements? a. the prior year's financial statements are restated following the purchase of another company in the current year b. a departure from generally accepted accounting principles caused an adverse opinion on the prior year's financial statements, and those prior year statements have been properly restated c. a change in accounting principles causes the auditor to make a consistency modification in the current year's audit report d. a scope limitation caused a qualified opinion on the prior year's financial statements, but the current year's opinion is properly unqualified.
a departure from generally accepted accounting principles caused an adverse opinion on the prior year's financial statements, and those prior year statements have been properly restated
AnnaLisa, an auditor for N. M. Neal & Associates, is prevented by the management of Lileah Company from auditing controls over inventory. Lileah is a public company. Management explains that controls over inventory were recently implemented by a highly regarded public accounting firm that the entity hired as a consultant and insists that it is a waste of time for AnnaLisa to evaluate these controls. Inventory is a material account, but procedures performed as part of the financial statement audit indicate the account is fairly stated. AnnaLisa found no material weaknesses in any other area of the entity's internal control relating to financial reporting. What kind of report should AnnaLisa issue on the effectiveness of Lileah's internal control? a. an unqualified report b. an adverse report c. a disclaimer of opinion d. an exculpatory opinion
a disclaimer of opinion
Engagement quality review
a review by a quality review partner of the financial statements and audit report to ensure the audit was properly conducted and an appropriate report issued
When an auditor is asked to express an opinion on an entity's rent and royalty revenues, he or she may a. not accept the engagement because to do so would be tantamount to agreeing to issue a piecemeal opinion b. not accept the engagement unless also engaged to audit the full financial statements of the entity c. accept the engagement, provided the auditor's opinion is expressed in a special report that clearly states that only these specific accounts were audited d. accept the engagement, provided distribution of the auditor's report is limited to the entity's management
accept the engagement, provided the auditor's opinion is expressed in a special report that clearly states that only these specific accounts were audited
In auditing ICFR for a public company, Emily finds that the entity has a significant subsidiary located in a foreign country. Emily's accounting firm has no offices in that country, and the entity has thus engaged another reputable firm to conduct the audit of internal control for that subsidiary. The other auditor's report indicates that there are no material weaknesses in the foreign subsidiary's ICFR. What should Emily do? a. disclaim an opinion because she cannot rely on the opinion of another auditor in dealing with a significant subsidiary b. accept the other auditor's opinion and express an unqualified opinion, making no reference to the other auditor's report in her audit opinion c. accept the other auditor's opinion after evaluating the auditor's work and make reference to the other auditor's report in her audit opinion d. qualify the opinion because she is unable to conduct the testing herself and this constitutes a significant scope limitation
accept the other auditor's opinion after evaluating the auditor's work and make reference to the other auditor's report in her audit opinion
Which of the following is an example of fraudulent financial reporting? a. company management falsifies the inventory count, thereby overstating ending inventory and understanding cost of sales b. an employee diverts customer payments to his personal use, concealing his actions by debiting an expense account, thus overstating expenses c. an employee steals inventory, and the shrinkage is recorded as a costs of goods sold d. an employees borrows small tools from the company and neglects to return them;the cost is reported as a miscellaneous operating expense
company management falsifies the inventory count, thereby overstating ending inventory and understanding cost of sales
Jefferson Corp., a major customer of Tracy Corp., filed for bankruptcy on February 1, 20X2 as a result of continued declining financial health. Jefferson had recently begun to pay late, and the bankruptcy makes it doubtful that Tracy will be able to collect the remaining balance. The allowance for doubtful accounts does not adequately cover Jefferson's 12/31 account balance.
company: adjusts the 12/31/X1 financial statements --> type 1
Washington Corp., a major customer of Tracy Corp., filed for bankruptcy on February 1, 20X2 as a result of an uninsured casualty loss in January that has left the company unable to continue operations. Although Washington had been a good customer who always paid in a timely manner, the bankruptcy makes it doubtful that Tracy will be able to collect any of the remaining outstanding accounts receivable balance.
company: discloses the information in a footnote in the 12/31/X1 financial statements --> type 2 auditor: emphasis paragraph may be added to the auditor report
Tracy Corp. entered into a merger agreement on February 28, 20X2 that significantly alters the company's stockholders' equity. The auditor is aware of this event
company: discloses the information in a footnote in the 12/31/X1 financial statements --> type 2 auditor: emphasis paragraph may be added to the auditor report AND also consider dual dating the report
In June 20X2, while performing some preliminary audit procedures for the 20X2 audit, Zig and Zag discover a problem with Tracy's accounts receivable accounting system. After further investigation, they discover that this problem, which was also present during the prior year, resulted in a material misstatement on the 12/31/X1 accounts receivable balance.
company: recalls and restates the 12/31/X1 financial statements that were issued on March 6
Independent internal verification of inventory (i.e. proper segregation of duties) occurs when employees who a. issue raw materials obtain materials requisitions for each issue and prepare daily totals of materials issued b. compare records of goods on hand with physical quantities do not maintain the records or have custody of the inventory c. obtain receipts for the transfer of completed work to finished goods prepare a completed production report d. are independent of issuing production orders update records from completed job cost sheets and production cost reports on a timely basis
compare records of goods on hands with physical quantities do not maintain the records or have custody of the inventory
Which audit procedure goes well with this specific assertion? Determine whether recorded accounts payable are valid (existence/occurrence)
compare selected amounts from the accounts payable listing with the voucher and supporting documents
Lookback testing #2
compare this year's estimate to activity occurring thru field work completion. this may either refute or confirm that adequacy of the current year estimate, depending on how long it typically takes the estimated activity to occur
If the independent auditors decide that it is efficient to consider how the work performed by the internal auditors may affect the nature, timing, and extent of audit procedures, they should assess the internal auditors' a. competence and objectivity b. efficiency and experience c. independence and review skills d. training and supervisory skills
competence and objectivity
Common test of details for accounts payable and other accounts: perform search for unrecorded liabilities (tricky for test for absence of something, rather than existence)
completeness
If the number of days' sales in accounts receivable (365 days/receivables turnover) decreases significantly, which of the following assertions for accounts receivable most likely is violated? a. existence or occurrence b. completeness c. rights and obligations d. classification
completeness
Typical cash disbursement controls: daily cash disbursements journal total reconciled to daily accounts payable postings
completeness
Typical cash disbursement controls: pre-numbered checks
completeness
If a lawyer refuses to furnish corroborating information regarding litigation, claims, and assessments, the auditor should: a. consider the refusal to be a scope limitation b. disclose this fact in a footnote to the financial statements c. seek to obtain the corroborating information from management d. honor the confidentiality of the client-lawyer relationship
consider the refusal to be a scope limitation
Which of the following statements best explains why public accounting, as a profession, promulgates ethical standards and establishes means for ensuring their observance? a. vigorous enforcement of an established code of ethics is the best way to prevent unscrupulous acts b. ethical standards that emphasize excellence in performance over material rewards establish individual reputations for competence and character c. ethical standards are established so that users of accounting services know what to expect and accounting professionals know what behaviors are acceptable, and so that discipline can be applied when necessary d. a requirement for a profession is to establish ethical standards that primarily stress responsibility to entities and colleagues
ethical standards are established so that users of accounting services know what to expect and accounting professional know what behaviors are acceptable, and so that discipline can be applied when necessary
review bills of lading for large inventory purchases received the last 2 days of December and the first 2 days of January and determine that each purchase was recorded in the correct period
evidence type: inspection of documents/records assertion: valuation/allocation- cutoff
Review the general ledger for large or unusual entries in December that may represent fictitious sales
evidence type: scanning assertion: occurrence
An auditor's tests of controls over the issuance of raw materials to production would most likely include a. reconciliation of raw materials and work-in-process perpetual inventory records to general ledger balances b. inquiry of the custodian about the procedures followed when defective materials are received from vendors c. observation that raw materials are stored in secure areas that storeroom security is supervised by a responsible individual d. examination of materials requisitions and reperformance of entity controls designed to process and record issuances
examination of materials requisitions and reperformance of entity controls designed to process and record issuances
Which of the following procedures would an auditor most likely perform to obtain evidence about the occurrence of any changes in internal control that might affect financial reporting between the end of the reporting period and the date of the auditor's report? a. review a file insurance settlement during the subsequent period b. examine relevant internal audit reports issued during the subsequent period c. inquire of the entity's legal counsel concerning litigation, claims, and assessments arising after year-end d. confirm bank accounts established after year-end
examine relevant internal audit reports issued during the subsequent period
When auditing contingent liabilities, which of the following procedures would be least effective? a. examining vendor confirmation replies b. examining invoices for legal services c. reading the minutes of the board of directors d. obtaining a legal letter
examining vendor confirmation replies
Common test of details for accounts payable and other accounts: obtain vendor statements for selected accounts on accounts payable listing and reconcile totals
existence/occurrence
The auditing standards that are used to guide the conduct of the audit are a. implicitly referred to in the critical audit matters section of the auditor's standard report b. explicitly referred to in the critical audit matters section of the auditor's standard report c. implicitly referred to in the basis for opinion section of the auditor's standard report d. explicitly referred to in the basis for opinion section of the auditor's standard report e. implicitly referred to in the opinion section of the auditor's standard report f. explicitly referred to in the opinion section of the auditor's standard report
explicitly referred to in the basis for opinion section of the auditor's standard report
Which of the following statements relating to attest and assurance services is not correct? a. independence is an important attribute of assurance service providers b. assurance services can be performed to improve the quality or context of information for decision makers c. financial statement auditing is a form of attest service but it is not an assurance service d. in performing an attest service, the CPA determines the correspondence of the subject matter (or an assertion about the subject matter) against criteria that are suitable and available to users
financial statement auditing is a form of attest service but it is not an assurance service
What concerns about inventory transactions and balances pairs with the VA-Accuracy assertion?
inventory quantities or costs not properly recorded
The highest-quality and most reliable audit evidence that segregation of duties is properly implemented is obtained by a. inspection of documents prepared by a third party but which contains the initials of those apply entity controls b. observation by the auditor of the employees performing control activities c. inspection of a flowchart of duties performed and available personnel d. inquiries of employees who apply control activities
observation by the auditor of the employees performing control activities
Which audit procedures goes well with this specific assertion? Determine whether accounts payable have been properly accumulated from the journal to the general ledger (accuracy)
obtain a listing of the accounts payable and agree total to the general ledger control account
The existence of audit risk is recognized by the statement in the auditor's standard report that the auditor a. obtains reasonable assurance about whether the financial statements are free of material misstatement b. assesses the accounting principles used and evaluates the overall financial statement presentation c. realizes that some matters, either individually or in the aggregation, are important, while other matters are not important d. is responsible for expressing an opinion on the financial statements, which are the responsibility of management
obtains reasonable assurance about whether the financial statements are free of material misstatement
Typical purchase transaction controls: voucher packets cancelled after payment; request for payment requires original vendor invoice
occurrence
Management assertions related to the processing of transactions
occurrence, completeness, VA-Accuracy, VA-Cutoff, VA-Classification
Cash receipts controls: monthly bank reconciliations
occurrence, completeness, accuracy
Typical purchase transaction controls: department approval (requisition) required for purchases; approved purchases order initiates purchasing process
occurrence; VA- accuracy/authorization
Breach of contract
occurs when the client or auditor fails to meet the terms and obligations established in the contract (either expressly or implied), which is normally finalized in the engagement letter. Third parties may have privity or near privity of contract.
During the audit of Moon Co., the auditor disagrees with management's estimation of collectible accounts receivable. The possible misstatement amount is material. Which of the statements below should weigh most heavily for the auditor in this instance? a. Moon management has the right to make company estimates b. Requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information c. There is a small but reasonable chance that accounts receivable as stated by Moon Co. might turn out to be fully collectible d. The interests of Moon Co., the auditor, and the public should be weighed equally in the decision
requiring an adjustment to the allowance for doubtful accounts would give stockholders access to fair and adequate information
Which of the following audit procedures is best for identifying unrecorded trade accounts payable? a. examination of unusual relationships between monthly accounts payable balances and recorded cash payments b. reconciliation of vendors' statements to the file of receiving reports to identify items received just prior to the balance sheet date c. investigation of payables recorded just prior to and just subsequent to the balance sheet date to determine whether they are supported by receiving reports d. review of cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period
review of cash disbursements recorded subsequent to the balance sheet date to determine whether the related payables apply to the prior period
Test of details for AR and related accounts: Review bank confirmations for evidence of receivables pledged as collateral; Review BOD minutes for factoring of A/R
rights and obligations
Which of the following internal controls would be most likely to deter the lapping of collections from customers? a. independent internal verification of dates of entry in the cash receipts journal with dates of daily cash summaries b. authorization of write-offs of uncollectible accounts by a supervisor independent of the credit approval function c. segregation of duties between receiving cash and posting the accounts receivable ledger d. supervisory comparison of the daily cash summary with the sum of the cash receipts journal entries
segregation of duties between receiving cash and posting the accounts receivable ledger
Occurrence assertion: a purchase is recorded, but no goods were received
segregation of duties, have presence of authorized purchase order and receiving report. Numerical sequence of receiving reports and vouchers
Which audit procedures goes well with this specific assertion? Ensure that recorded inventory quantities include all products on hand (completeness)
select a sample of items during the physical inventory count and determine that they have been included on count sheet
Which audit procedure matches with this assertion: verify that all accounts receivable are recorded in the correct period (cutoff)
select a sample of shipping documents for a few days before and after year-end
Cash equivalents
short-term, highly liquid investments that are readily convertible to cash or so near their maturity that there is little risk of change in their value (e.g. money market funds, treasury bills)
Fraud risks in revenue recognition
side agreements: arrangements that are used to alter the terms and conditions of recorded sales in order to entice customers to accept delivery of goods and services -channel stuffing: a marketing practice that suppliers sometimes used to boost sales by inducing distributors to buy substantially more inventory than they can promptly resell -related-party transactions -bill and hold sales: sales where the customer agrees to purchase the goods but the seller retains physical possession until the customer requests shipment
Significant deficiencies and material weaknesses must be communicated to an entity's audit committee because they represent a. material fraud or illegal acts perpetrated by high-level management b. disclosures of information that significantly contradict the auditor's going concern assumption c. significant deficiencies in the design or operation of internal control d. potential manipulation or falsification of accounting records
significant deficiencies in the design or operation of internal control
The audit firm's valuation specialist would likely be brought in to assist in the audit of fair value measurements at an entity when the following is present a. the entity is a new audit client b. significant uncertainty exists in key inputs to the entity's valuation models c. the entity has a financial instrument with a Level 2 input d. the entity owns a large and diverse portfolio of publicly traded stock
significant uncertainty exists in key inputs to the entity;s valuation models
The auditor is concerned that checks written in payment on account for purchases are not written or recorded for the correct dollar amount of the purchase Design a test of transactions that tests the VA-Accuracy assertion for cash disbursements
the daily disbursements should be reconciled to checks daily and vendor statements reconciled to A/P records obtain sample of disbursements from cash disbursements journal --> select sample of checks that are greater than $500 from the cash disbursements journal that need supervisor pre-approval review reconciliation and vendor invoice to see if (1) math is correct (2) reconcile checks
The substantive analytical procedure known as trend analysis is best described by a. the comparison, across time or to a benchmark, of relationships between financial statement accounts or between an account and non-financial data b. Development of a model to form an expectation using financial data, non-financial data, or both in test account balances or changes in account balances between accounting periods c. the examination of changes in an account over time d. the comparison of common-size financial statements over time
the examination of changes in an account over time
Which of the following events occurring after the issuance of a set of financial statements and the accompanying auditor's report would be most likely to cause the auditor to make further inquiries about the financial statements? a. a technological development in the industry that could affect the entity's future ability to continue as a going concern b. the entity's sale of a subsidiary that accounts for 30 percent of the entity's consolidated sales c. the discovery of information regarding a contingency that existed before the financial statements were issued d. the final resolution of a lawsuit explained in a separate paragraph of the auditor's report
the final resolution of a lawsuit explained in a separate paragraph on the auditor's report
Which of the following is not a factor that might affect the likelihood that a control deficiency could result in a misstatement in an account balance? a. the susceptibility of the related assets or liability to loss or fraud b. the interaction or relationship of the control with other controls c. the financial statement amounts exposed to the deficiency d. the nature of the financial statement accounts, disclosures, and assertions involved
the financial statement amounts exposed to the deficiency
Which of the following controls would most effectively ensure that the proper custody of assets in the investing process is maintained? a. direct access to securities in the safe-deposit box is limited to one corporate office b. personnel who post investment transactions to the general ledger are not permitted to update the investment subsidiary ledger c. purchase and sale of investments are executed on the specific authorization of the board of directors d. the recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safe-deposit box by independent personnel
the recorded balances in the investment subsidiary ledger are periodically compared with the contents of the safe-deposit box by the independent personnel
Tolerable and Expected Error
the relation between these two is actually the most significant factor in sample size. If expected > tolerable, you probably won't bother to sample and test to begin with Therefore, in cases where you are sampling and testing, tolerable > expected
Risk of material misstatement
the risk that the financial statements are materially misstated prior to the audit. it represents the combination of inherent risk and ontrol risk
Which of the following is not a provision of the Sarbanes-Oxley Act? a. a requirement to retain audit work papers for at least five years b. it is a criminal offense to take any harmful action in retaliation against anyone who voluntarily comes forward to report a suspected accounting or securities fraud c. broad investigative and disciplinary authority over registered public accounting firms is granted to the Public Company Accounting Oversight Board d. the statute of limitations for actions under Section 10(b) and rule 10b-5 was reduced to one year from the discovery of fraud and five years after the fraud occurred.
the statute of limitations for actions under Section 10(b) and rule 10b-5 was reduced to one year from the discovery of fraud and five years after the fraud occurred
Upper misstatement limit
the total of the projected misstatement plus the allowance for sampling risk
When goods are received, the receiving clerk should match the goods with a. the purchase order and the requisition form b. the vendor invoice and the purchase order c. the vendor shipping document and the purchase order d. the vendor invoice and the vendor shipping document
the vendor shipping document and the purchase order
When auditors report on the effectiveness of internal control "as of" a specific date and obtain evidence about the operating effectiveness of controls at an interim date, which of the following items would be the least helpful in evaluating the additional evidence to gather for the remaining period? a. any significant changes that occurred in internal control subsequent to the interim date b. the length of the remaining period c. the specific controls tested prior to the "as of" date and the results of those tests d. the walkthrough of the control system conducted at interim
the walkthrough of the control system conducted at interim
For what primary purpose does the auditor obtain an understanding of the entity and its environment? a. to determine the audit fee b. to decide which facts about the entity to include in the audit report c. to plan the audit and determine the nature, timing, and extent, of audit procedures to be performed d. to limit audit risk to an appropriately high level
to plan the audit and determine the nature, timing, and extent, of audit procedures to be performed
2. ordinary negligence
to prevail, plaintiff must prove: 1. auditor owed a duty of care 2. audit breached a duty of care (lack of due care) 3. plaintiff suffered actual damages or loss 4. direct casual connection between auditor's negligence and plaintiff's damages auditor defenses 1.non-negligent performance/due care (GAAS/PCAOB standards were followed) 2. no duty owed 3. no loss suffered 4. contributory or comparative negligence or fraud (plaintiff also at fault") 5. absence of casual connection (another reason for the loss) 6. expired statute of limitations
Which type of test and management assertion should be used for the following test: Compare a random sample of duplicate sales invoices to the related supporting shipping documents to determine that a shipment was made, and determine agreement of amount shipped to amount billed.
type of test: substantive test of transactions management assertion: existence, accuracy
Which type of test and management assertion should be used for the following test: Examine sales returns documentation for evidence of approval by authorized personnel
type of test: test of control management assertion: authorization
Which type of test and management assertion goes with this test? For a random sample of check disbursements, determine that each is supported by an authorized purchase order
type of test: test of controls management assertion: authorization
Which type of test and management assertion should be used for the following test: Obtain the accounts receivable subsidiary ledger as of the balance sheet date. Foot and trace the total to the general ledger
type of test: test of details of balance management assertion: accuracy- math and tie-in
Which type of test and management assertion goes with this test? Perform a search for unrecorded liabilities as follows: review cash disbursements made during the 14 days after the balance sheet date and unpaid invoices received for 14 days after the balance sheet date. Examine supporting documentation to determine whether these are items that should have been accrued as of 12/31, and if so, verify that they were appropriately accrued
type of test: test of details of balances management assertion: completeness/cut-off
Which type of test and management assertion should be used for the following test: Discuss the collectibility of specific customer accounts with management
type of test: test of details of the balances management assertion: net realizable value
When compiling the financial statements of a non-public entity, an accountant should a. review agreements with financial institutions for restrictions on cash balances b. understand the accounting principles and practices of the entity's industry c. inquire of key personnel concerning related parties and subsequent events d. perform ratio analyses of the financial data of comparable prior periods
understand the accounting principles and practices of the entity's industry
The auditor's risk assessment process
understand the company and its business -how do they make money? -key supplier/customer relationships; key transactions -industry issues and conditions; regulatory issues -management strategies and objectives -performance (analytical procedures/ratio analysis) identify business risks that could result in material misstatements to the F/S identify accounting risks (complexity, subjective estimates) understand internal control assess risk of material misstatement and determine audit procedures needed
Which of the following is the most important reason for an auditor to gain an understanding of an audit client's system of internal control over financial reporting? a. understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely b. understanding a client's system of internal control can help the auditor make valuable recommendations to management at the end of the engagement c. understanding a client's system of internal control can help the auditor see consulting services to the clients d. understanding a client's system of internal control is not a required part of the audit process
understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely
Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's a. awareness of the consistency in the application of generally accepted accounting principles between periods b. evaluation of all matters of continuing accounting significance c. opinion of any subsequent events occurring since the predecessor's audit report was issued d. understanding as to the reasons for the change of auditors
understanding as to the reasons for the change of auditors
Which of the following sampling methods would be used to estimate a numeric measurement of a population, such as a dollar value? a. random sampling b. numeric sampling c. attribute sampling d. variable sampling
variable sampling
Audit procedures
-specific acts performed by the auditor to gather evidence to determine if specific assertions are being met 1. risk assessment procedures 2. test of controls 3. substantive procedures
Audit program
-a set of audit steps designed to test assertions for a particular business process or account -each step generally tied directly to the assertion(s) being tested -the team member completing the procedures "sign off"
Preliminary analytical procedures (required)
-assist the auditor to better understand the business and assess RMM in order to plan the nature, timing, and extent of audit procedures. -generally done at a "high" level
Current files
-Audit plan audit report -Adjusting journal entries -Audit programs -Reclassification journal entries -Working trial balance -Current financial statements -Minutes of meetings -Working papers supporting accounts
Analytical procedures used as substantive tests Purpose: to substantiate that a recorded balance is fairly stated
1. develop expectation -from prior years, budgets, industry information, non-financial data -the more precise the expectation, the more reliable the test 2. define tolerable difference -often depends on the significance of the account, precision of the expectation 3. investigate differences > tolerable difference -corroborate client expectations with other forms of evidence, and maintain professional skepticism sometimes analytical procedures are not appropriate, and a different type of substantive procedures is necessary
Confirmation
A confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party (the confirming party) in paper form or by electronic or other media.
Direction of testing example #1
Suppose an auditor is concerned that some items included in the client's PPE balance are fictitious. Think about how this could be tested. Which assertion is the auditor concerned with? -existence
Audit documentation (working papers)
The auditor's principal record of the work performed and the basis for the conclusions in the auditor's report. It also facilitates the planning, performance, and supervision of the engagement and provides the basis for the review of the quality of the work by providing the reviewer with written documentation of the evidence supporting the auditor's significant conclusions.
Non-sampling risk
The risk that auditors will make judgment errors caused by the use of inappropriate audit procedures or misinterpretation of audit evidence and failure to recognize a misstatement or deviation.
Engagement risk
The risk that the auditor is exposed to financial loss or damage to his or her professional reputation from litigation, adverse publicity, or other events arising in connection with financial statements audited and reported on.
in testing the existence assertion for an asset, the auditor normally works from the ______ to the _______ a. financial statements to the potentially unrecorded items b. potentially unrecorded items to the financial statements c. accounting records to the supporting documents d. supporting documents to the accounting records
accounting records to the supporting documents
generally performed after the balance sheet date
substantive
the auditor develops an expectation and a tolerable difference
substantive
Errors
the unintentional misstatements or omissions of amounts or disclosures in financial statements