Audit 3rd Part

premature

revenue recognition of this type occurs before accounting standards' requirements for recording revenues have been met (i.e. recording next pd's sales in this pd)

engagement quality review

review of the financial statements and the entire set of audit files by a completely independent reviewer to whom the audit team must justify the evidence accumulated and the conclusions reached; aka the "independent review"

financial reporting

risk factors for _________________: -*incentives/pressures*: financial stability is threatened by economic, industry, entity operating conditions; excessive pressure for MGMT to meet debt requirements -*opportunities*: if company has poor internal controls, significant accounting estimates that are difficult to verify, ineffective oversight after financial reporting, high turnover/ineffective accounting/internal audit/IT staff -*attitudes/rationalization*: inappropriate/inefficient communication and support for entity's values, history of violations, mgmt makes unrealistic/overly-aggressive forecasts -will try to shift rules & regs

misappropriation of assets

risk factors for __________________: -*incentives/pressures*: personal financial obligations, adversarial relations bw employees and mgmt, want to "stick it to the company" -*opportunities*: large amount of cash/inventory items on hand, inadequate control over assets -attitudes/rationalization: disregard for need to monitor, disregard for internal controls

audit committee

selected # of members of a company's BOD who must help auditor remain independent

ethics

set of moral principles/values necessary for society to function in an orderly manner

examination

similar to an audit, in that there are management assertions involved and the auditor expresses an *opinion* on those assertions based on extensive testing and collection of evidence - *reasonable assurance*

performance audits

similar to operational audits, except they include: -economy and efficiency audits -program audits to determine effectiveness, achievement, compliance of the function

related

some indications of ____________-party transactions: -lending/borrowing at unusual interest rates -assets purchased/sold at unusual prices -sales w/o substance -PMTs for services rendered at inflated prices

basic financial statements, supplementary info

supplementary info consists of __________________ (plain vanilla, includes basic financials and supplementary info, *is covered by standard audit report*) and ___________________ (includes detailed comparative statements, statistical data, schedule of insurance coverage, requires *explanatory paragraph*)

revenue

susceptible to manipulation bc it's the largest amount on the income statement and therefore a misstatement only representing a small % of revenues can still have a large effect on income

leverage

the amount of debt or equity that an entity uses to buy more assets

lack of privity

the auditor cannot be held liable to the plaintiff, but in cases of gross negligence or fraud, that principle wouldn't apply.

vertical analysis

type of analytical procedure where FS #s are converted to %

horizontal analysis

type of analytical procedure where account balance is compared to the previous pd and the % change in the pd's account balances is calculated

financial, misappropriation, assets

types of fraud: -fraudulent _________ reporting -_____________ of ____________

informational inquiry

used to obtain info about facts & details usually about past/current processes

independence

value that is the cornerstone of auditing & the first part of the AICPA conduct code

pressure, opportunity, rationalization

what 3 factors make up the fraud triangle?

letter of representation

written communication from the client to the auditor formalizing statements that the client has made about matters pertinent to the audit

Federal Reserve Act

-1913 legislation -established the Federal Reserve Board to oversee the country's banking system

Clayton Antitrust Act

-1914 -established Federal Trade Commission (FTC) and authorized it to investigate deceptive and unfair trade practices

Tenants' Corp

-1963-1965: Jeremy Riker embezzled $130,000 from tenants of a NYC apartment building, but the tenants sued the building's accountants -highlighted the importance of an *engagement letter* to specify the auditor's responsibilities (and also the importance of legal liability of CPA associated with *unaudited financial statements*) -led to the Accounting and Review Services Committee to set standards for accountants to follow when performing nonaudit services

King Resources

-1968 -Arthur Andersen auditors discovered, but failed to report, that the company overcharged Fund of Funds millions of dollars on land transactions -FoF's subsequent lawsuit against Arthur Andersen for breach of contract resulted in an $81mil judgment against the accounting firm -"the single worst thing that has happened to the accounting profession" about the verdict

channel stuffing

-a deceptive business practice used by a company to inflate its sales and earnings figures by deliberately sending retailers along its distribution channel more products than they are able to sell to the public. -involved with fraudulent financial reporting

classification

-a presentation & disclosure objective -financial info is appropriately presented -assets and liabilities are properly-classified as current or LT -auditor should read footnotes for clarity

valuation

-a presentation & disclosure objective -financial info is disclosed at appropriate amounts -auditor should reconcile amounts to financial statements & workpapers and to info examined and supported in auditor's long-term audit files

materiality

-affects whether ownership is a violation of independence only for indirect ownership (i.e. as a % of personal wealth)

SAS 59

-answers the question: "How do auditors communicate and how can they be more transparent with the board?" -auditors must assess client's likelihood of continuing as a going concern

co-contracting

-common business practice in which two or more firms pool their expertise to provide services better than those any single company can provide

other info

-included in annual reports -auditor must read this, according to auditing standards

indirect, income

-materiality is only considered for ________ financial interests (i.e. ownership of client stock thru a *mutual fund*) -materiality must be considered in relation to the member's personal wealth or __________

business failure

-occurs when a business is unable to repay lenders or meet expectations of its investors bc of economic or business conditions, poor mgmt decisions, or unexpected competition in the industry

LE&W

-one determinant of fraud: includes opportunity, motive, and attitude

Craig v Anyon

-one of the earliest court decisions establishing auditors' liability to clients

8,064

-the number of independence violations by PwC partners and employees alleged to an anonymous letter written to the SEC -many cases of auditors owning stock in their clients' businesses

fraudulent financial reporting

-type of fraud -for *AP*, includes: -failure to record AP -fictitious reductions in AP -allowances for promotions/advertising (i.e. false reporting for coupons, understating AP understates COGS) -warning signs: analytical procedures: *days cogs in AP*

misappropriation of assets

-type of fraud -for *AP*, includes: -pmts to fictitious revenues -theft of legitimate checks -theft of duplicate checks (pmt vouchers are resubmitted for cash disbursements) -warning signs: analytical procedures like *days cogs in AP*, or *duplicate items on bank reconciliations*

fraudulent financial reporting

-type of fraud -for *fixed assets*, includes: -fictitious assets -improperly-capitalized costs warning signs: analytical procedures like *repairs & maintenance %*

misappropriation of assets

-type of fraud -for *fixed assets*, includes: -theft of property/equipment -warning signs: inadequate physical controls around fixed assets

organizational

1 of 3 types of operational audits that includes the entire organization and focuses on the interaction between functions

functional

1 of 3 types of operational audits that's focused on one particular area of an org., i.e. payroll, HR, manufacturing

special assignment

1 of 3 types of operational audits that's tailored to specific requests from mgmt

scienter

1976, Hochfelder vs. Ernst & Ernst: defined this as knowledge and an intent to deceive -fourth thing plaintiff must prove under Rule 10b-5 of the Securities Act of 1934

existence

1st step in auditing contingencies: determine their _______________, inquire of mgmt, review agent reports for income statement settlements, review minutes of mtgs, analyze legal expenses for the pd, obtain lawyers' letters about impending litigation status, review audit documentation, examine credit letters

quality control systems, independence, role of audit committee

2 additional considerations for Rule 2-01

independence, compliance

2 most important qualities for an operational auditor?

fair value

2 primary approaches to deal w/ uncertainty in loss contingencies: 1. measure contingency using ____________ approach 2. uses probability threshold w/ 3 levels: remote, reasonably-possible, probable

fictitious, premature, manipulation

3 main types of revenue manipulation: 1. _________ revenues (creation is most egregious) 2. _________ revenue recognition 3. _________ of adjustments to revenue (i.e. most common is to sales returns & allowances)

performance, performance, bias

3 reasons why an experienced member of the audit firm must review everything well @ audit's end: 1. evaluate __________ of inexperienced ppl 2. make sure that the audit meets the CPA firm's _____________ standard 3. counteract the ___________ that often enters the auditor's judgment

determinants of fraud

3 types of these, including: -SAS 53 -LE&W -SAS 99: "Fraud triangle"

internal control, scope, minutes, evidence

5 requirements for review engagements of public companies: 1. Bc an annual audit is also performed for the public client, the auditor must obtain sufficient information about the client's _____________ for both annual and interim financial information 2. The auditor's knowledge of the results of the annual audit procedures is used in considering the ____________ and results of the inquiries and analytical procedures for the review 3. Under SSARS, the auditor makes inquiries about actions taken at directors' and stockholders' mtgs; for a public company, the auditor reads the __________ of those meetings 4. The auditor must also obtain ___________ that the interim financial info agrees or reconciles with the accounting records for a public company interim review

independent reivew

= engagement quality review, reqd. for SEC engagements

foreseen users

=members of a limited class of users that the auditor knows will rely on the financial statements -these 3 legal landmarks exemplified this concept: -Credit Alliance v Arthur Andersen (NY state court of appeals) -Restatement of Torts -Forseeable user

1

A Type 1 service auditor's report on internal controls at a service organization... 1. includes an opinion about the suitability of the design of controls and substantive tests of transactions at the service organization 2. is based on the performance of tests of controls and SToT at the service org 3. contains an opinion about the fair presentation of the service org's financial statements in accordance with accounting standards 4. provides an opinion about the fair presentation of the service org's financial statements in accordance with accounting standards

review services

A ___________ ____________ engagement (SSARS Review) allows the accountant to express *limited assurance* that the financial statements are in accordance with applicable accounting standards, or other comprehensive basis of accounting (OCBOA) -CPAs must be *independent* of the client for review service engagements -suggested procedures include *inquiries of mgmt and analytical procedures* -accountants don't obtain an understanding of internal control, test controls, assess fraud risk, or do substantive tests of transactions/tests of balances

A

A company guarantees the debt of an affiliate. Which of the following best describes the audit procedure that would make the auditor aware of the guarantee? A. Review minutes and resolutions of the board of directors. B. Review prior year's audit files with respect to such guarantees. C. Review the possibility of such guarantees with the chief accountant. D. Review the legal letter returned by the company's outside legal counsel.

bylaws

AICPA ___________ describe discreditable acts as punishable crimes that include imprisonment for 1+ years, tax evasion, personal tax fraud, helping in tax fraud

protection, auditing, limits

AICPA and Accounting Profession can reduce exposure to lawsuits by... 1. seeking ___________ from non-meritorious litigation 2. improving ___________ to better meet users' needs 3. educating users about the ________ of auditing-Examples of specific activities: -standard and rule setting -oppose lawsuits -education of users -sanction members for improper conduct & performance -lobby for legal changes

quality, control

Additional Considerations for Rule 2-01: __________ ____________ systems: If a covered person violates rule 2-01, but the firm has met certain conditions, the firm's independence wouldn't be considered impaired solely because the covered person wasn't dependent (e.g. the firm must have quality control system related to independence, which includes both preventive - i.e. independence - training and detective - inspection - components

A

An auditor's purpose in reviewing credit ratings of customers with delinquent accounts receivable most likely is to obtain evidence concerning management's assertions about A. Valuation and allocation B. Completeness C. Existence D. Rights and obligations

D

Analytical procedures used in planning an audit should focus on identifying A. Material weaknesses in internal control B. The predictability of financial data from individual transactions C. The various assertions that are embodied in the financial statements D. Areas that may represent specific risks relevant to the audit

D

Analytical procedures used in planning an audit should focus on identifying... A. Material weaknesses in internal control B. The predictability of financial data from individual transactions C. The various assertions that are embodied in the financial statements D. Areas that may represent specific risks relevant to the audit

contingent liabilities, contingencies

Auditor's primary goals in verifying contingent liabilities: 1. evaluate accounting treatment of known ______________________ to determine whether mgmt has properly classified the contingency (classification, presentation & disclosure objectives) 2. identify any ____________ not already identified by mgmt (completeness, presentation & disclosure objectives)

B

Auditors will generally send a standard inquiry letter to: A. only those attorneys who have devoted substantial time to client matters during the year. B. every attorney that the client has been involved with in the current or preceding year, plus any attorney the client engages on occasion. C. those attorneys whom the client relies on for advice related to substantial legal matters. D. only the attorney who represents the client in proceeding where the client is defendant.

outside

Auditors will report fraud to those _________ the firm when: 1. responding to an 8k 2. responding to an inquiry by a successor auditor 3. subpoenaed 4. required by a government regulatory or funding agency 5. BOD fails to do so under the Securities Reform Act of 1995

attestation engagement

CPA, referred to as a "*practitioner*", reports on the reliability of info/assertion made by another party (i.e. bank requests CPA to report in writing whether an audit client has adhered to all requirements of a loan agreement)

text, verbal

Certified Fraud Examiners (CFE) frequently use _________ analysis and _________ cues to determine when ppl are being dihonest: 1. lack of self-reference 2. verb tense 3. answering questions w/ questions 4. equivocation (use of ambiguity to conceal the truth) 5. oaths ("I swear I didn't ...) 6. euphemism 7. alluding to actions 8. lack of detail 9. narrative balance: certain parts of the story are glossed over 10. mean length of utterance

earnings

Companies may intentionally understate earnings when income is high to create a reserve of "earnings" that may be used in future years to increase earnings. This practice is known as _____________-based management.

bill and hold sale

Company recognizes revenue on stuff they haven't shipped yet (valid if the customer is holding up delivery of the good)

B

For which of the following professional services must CPAs be independent? A. Management advisory services. B. Audits of financial statements. C. Preparation of tax returns. D. All three of the above.

lower, 24, assurance, GAGAS

GAGAS traditionally provide guidance on: 1. materiality/significance: thresholds of acceptable audit risk and materiality may be __________ than in GAAS audits 2. Quality Control: Auditors involved in GAGAS audits must devote at least ___________ of the required 80 hours of continuing education to subjects related to governmental accounting/auditing 3. compliance: Must provide reasonable ____________ re: misstatements arising from "noncompliance with provisions of contracts/grant agreements that have a material and direct effect on the FSs" 4. Reporting: Audit report must state that the audit was done in accordance with ____________

mgmt, committee

Ideally, the internal audit function reports directly to the audit _______________, but that isn't a requirement and isn't always the case

B

If a potential loss on a contingent liability is remote, the liability usually is: A. disclosed in footnotes, but not accrued. B. neither accrued nor disclosed in footnotes. C. accrued and indicated in the body of the financial statements. D. disclosed in the auditor's report but not disclosed on the financial statements

alleviated

If substantial doubt about going concern is ___________ because of mgmt's plans, auditor must disclose: -principal conditions -details of mgmt's plans -ability to continue is dependent on the realization of mgmt's plans

A

In third-party suits, which of the auditor's defenses contends lack of privity of contract? A. Lack of duty B. Non-negligent performance C. Contributory negligence D. Absence of causal connections

size, nature

Materiality depends on the __________, __________ of the misstatement.

A

One of the most important audit procedures to perform to assess the going concern question is: A. analytical procedures. B. confirmations of creditors. C. statistical sampling procedures. D. inquiries of client and its legal counsel.

consistent

Other info in the annual report: -auditors must review any information that is not a part of the financial statements but is published with them, such as the president's letter and the Management Discussions and Analysis (MD&A) -info must be ______________ with the financial statements (i.e. can't say "we had 22% sales growth" when they actually didn't!)

opinion shopping

PCAOB auditing standards limit the practice of CPA firms providing written or oral opinions on the applications of accounting principles or the type of audit opinion that would be issued in the event of some hypothetical transaction of an audit client of another CPA firm: company proposes shady accounting idea to audit companies that want to be hired

operational

Phases of ____________ auditing: planning, evidence accumulation, evaluating, reporting, followup

C

Privity of contract exists between: A. auditor and the federal government. B. auditor and third parties. C. auditor and client. D. auditor and client attorney.

B

Quincy bought Teal Corp. common stock in an offering registered under the Securities Act of 1933. Worth & Co., CPAs, gave an unqualified opinion on Teal's financial statements that were included in the registration statement filed with the SEC. Quincy sued Worth under the provisions of the 1933 Act that deal with omission of facts required to be in the registration statement. Quincy must prove that A. There was fraudulent activity by Worth B. There was a material misstatement in the financial statements C. Quincy relied on Worth's opinion D. Quincy was in privity with Worth

fraud

Responses to risk of __________ include: -using more experienced personnel, or even fraud specialists (i.e. less staff/interns on a client - send seniors instead!) -more manager/partner supervision: especially if company has previously committed fraud -more reliance on auditor examination and 3rd-party confirmation -> use your own, more expensive evidence (rather than analytical procedures) -heightened skepticism -more extensive substantive testing/larger sample size -sometimes partners show up to the audit too

going concern

SAS no 132 doesn't define this - just gives examples

review

SSARS requires the auditor to obtain the following for a __________: -agreement on the engagement terms (make sure client knows review is less extensive than an audit) -knowledge of the accounting principles and practices of the client's industry -knowledge of the client -make *inquiries of management* -perform *analytical procedures* -read the FSs -reconcile the financial statements to underlying accounting records -obtain a *letter of representation* -prepare documentation

plaintiff: loss (was suffered by investing in the registered security); (audited financial statements contained a) material omission or misstatement. Auditor: guilty until proven innocent (presumed to have been *negligent* unless he or she can prove otherwise.)

Section 11 under the Securities Act of 1933 treats claims against auditors more favorably than common law. What two things does a plaintiff need to prove to have a case against the auditor of a company in which they purchased new investments? What does the auditor have to do to have the case dismissed?

communication, inquiries, risk, analytical

Sources of info used to assess audit risk include: -__________ among audit team -__________ of mgmt - whether mgmt knows of fraud -__________ factors -__________ procedures - i.e. horizontal, vertical analysis -others

T

T/F: 3-rd party users not as common in operational audits as in financial ones

T

T/F: 54% of staff auditors committed at least one act of audit quality reduction during the specified engagement.

T

T/F: 6 core values according to Josephson Institute: 1. trustworthiness 2. respect 3. responsibility 4. fairness 5. caring 6. citizenship

T

T/F: AICPA code applies to all CPAs even if they aren't in public practice - some apply just to those in public practice, some just to those in private practice

T

T/F: AICPA is stricter on independence rules than the SEC

T

T/F: According to "Called to Account", an auditor's only real product is his/her credibility.

T

T/F: CPAs can't make mgmt decisions!

T

T/F: Generally, auditors who find fraud are restricted to sharing fraud suspicions to client *only* -If you quit or are fired by the client, the company still has to file an 8K as to your dismissal/departure

T

T/F: If they find evidence of fraud, auditors MUST report to top management and board of directors, and consider the need to issue a qualified or adverse opinion.

T

T/F: In 2002, as a result of Enron and Worldcom scandals, Congress passed SOX, which established the PCAOB, which regulates public accounting firms.

T

T/F: In order to audit additional or supplementary information, it has to be from the same period as the one under audit and the same materiality level must be used.

interest, own, mgmt, advocacy

The SEC's rules with respect to services provided by auditors are predicated on four basic principles of auditor objectivity and independence. What are the four basic principles? 1. an auditor should not have a mutual or conflicting __________ with the audit client 2. an auditor should not audit his or her ________ work 3. an auditor should not function in the role of ______ 4. an auditor should not serve in an ________ role for his or her client.

D

The Securities and Exchange Commission can impose all but which of the following sanctions? A. Suspend a CPA from auditing SEC clients. B. Prohibit a CPA from accepting new SEC clients for a period of time. C. Require a CPA to participate in continuing-education programs and make changes in their practice. D. Revoke a CPA license.

T

The Single Audit Act states that entities receiving *more than $750,000* of *federal funds* are subject to *single audits*, even if the funds come from more than one agency

C

The adverse effects of events causing an auditor to believe there is substantial doubt about an entity's ability to continue as a going concern would most likely be mitigated by evidence relating to the: A. Ability to expand operations into new product lines in the future. B. Feasibility of plans to purchase leased equipment at less than market value. C. Marketability of assets that management plans to sell. D. Committed arrangements to convert preferred stock to long-term debt.

A

The auditor's primary means of obtaining corroboration of management's information concerning litigation is a: A. Letter of audit inquiry to the client's lawyer. B. Letter of corroboration from the auditor's lawyer upon review of the legal documentation. C. Confirmation of claims and assessments from the other parties to the litigation. D. Confirmation of claims and assessments from an officer of the court presiding over the litigation.

C

The date of the management representation letter should coincide with the: A. Date of the latest subsequent event referred to in the notes to the financial statements. B. Balance sheet date. C. Date of the auditor's report. D. Date of the engagement agreement.

A

The partnership of Booth & Haynes, CPAs, has been engaged to examine the financial statements of Paul, Inc., in connection with the registration of Paul's securities with the Securities and Exchange Commission. Under these circumstances, which of the following statements is true? A. Booth & Haynes is assuming much greater third-party liability than it assumes on engagements under common law. B. If its examination is not fraudulent, Booth & Haynes may issue an appropriate disclaimer to the financial statements and thereby avoid liability. C. Booth & Haynes must incorporate if they wish to practice before the SEC. D. Booth & Haynes must be a large interstate firm if they wish to practice before the SEC.

GAO (Government Accountability Office)

The performance of gov audits is regulated by the __________, who issues the GAGAS, sometimes referred to as "*yellow book audits*"

B

The refusal of a client's attorney to provide a representation on the legality of a particular act committed by the client is generally: A. Sufficient reason to issue an adverse opinion. B. Considered to be a scope limitation. C. Insufficient reason to modify the auditor's report because of the attorney's obligation of confidentiality. D. Proper grounds to withdraw from the engagement without further consideration.

intro, mgmt, SSARS, negative

The standard review report includes 4 paragraphs: 1. an ___________ paragraph identifying the entity, the period of financial statements reviewed, stating that the accountant has conducted a review 2. specifying paragraph stating that ______________ is responsible for the preparation and fairness of the financial statements, and for designing, implementing, and maintaining internal controls relevant to financial reporting 3. paragraph noting the accountant's responsibility to conduct a review of mgmt's financial statements in accordance with ____________. Should include the heading "*Accountant's Responsibility*" 4. Fourth paragraph, preceded with the heading, "*Accountant's Conclusion*", expresses limited assurance in the form of _____________ assurance that "we are not aware of any material modifications that should be made to the accompanying financial statements."

D

The three general auditing standards are concerned with: A. Adequate training and proficiency of the auditor, proper planning and supervision, and due professional care. B. Adequate training and independence. C. Due professional care. D. Both b and c.

training, care

The three general standards for auditors are concerned with: Adequate _____________, independence, due professional ________

publicly

These nonaudit services can't be provided to __________-held audit clients: 1. bookkeeping and other accounting services 2. financial info systems design and implementation 3. appraisal/valuation services 4. actuarial services 5. internal audit outsourcing 6. mgmt or HR 7. IB services 8. legal/expert services 9. any other impermissible service according to the PCAOB

reasonable period of time

Two definitions (timelines): 1. PCAOB: = 1 yr after the BS date 2. FASB & AICPA: year from whenever the financials (like the BS) are *publicly-released*

reporting responsibilities

Under SAS no 132, if substantial doubt still exists after evaluating mgmt's plans, auditors must modify the audit report to include an explanatory paragraph - even when asset recoverability and liability amounts & classification aren't in question

B

Under the "Ultramares" doctrine, to which of the following parties will an accountant be liable for ordinary negligence? A. Parties in privity and foreseen parties B. Parties in privity but not foreseen parties C. Foreseen parties but not parties in privity D. Neither foreseen parties nor parties in privity

fictitious revenues, premature revenue recognition, manipulation of revenue adjustments

What are the three main types of revenue manipulations employed to commit fraudulent financial reporting

D

When audited financial statements are presented in a client's document containing other supplementary information, the auditor should: A. Perform inquiry and analytical procedures to ascertain whether the other information is reasonable. B. Add an explanatory paragraph to the auditor's report without changing the opinion on the financial statements. C. Perform the appropriate substantive auditing procedures to corroborate the other information. D. Read the other information to determine that it is consistent with the audited financial statements

C

When determining whether independence is impaired because of an ownership interest in a client company, materiality will affect ownership: A. in all circumstances. B. only for direct ownership. C. only for indirect ownership. D. under no circumstances

Proxy statement

Where can we find information about *audit fees*? -DEF 14A: ___________________: Where public companies most often report how much they can pay their auditors -10k: client companies required to report how much they pay auditors

D

Which of the following is not a factor that relates to opportunities to misappropriate assets? A. Inadequate internal controls over assets. B. Presence of large amounts of cash on hand. C. Inappropriate segregation of duties or independent checks on performance. D. Adverse relationships between management and employees.

B

Which of the following is something that the plaintiff must prove in order for an accountant to be liable for damages under Section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934? A. The accountant was ordinarily negligent B. There was a material omission C. The security involved was stock D. The security was part of an original issuance

D

Which of the following might be detected by an auditor's review of the client's sales cutoff? A. Excessive goods returned for credit B. Unrecorded sales discounts C. Lapping of year-end accounts receivable D. Inflated sales for the year

B

You are auditing Rodgers and Company. You are aware of a potential loss due to non-compliance with environmental regulations. Management has assessed that there is a 40% chance that a $10M payment could result from the non-compliance. The appropriate financial statement treatment is to: A. accrue a $4 million liability. B. disclose a liability and provide a range of outcomes. C. since there is less than a 50% chance of occurrence, ignore. D. since there is greater that a remote chance of occurrence, accrue the $10 million.

tort

________ actions brought against auditors more frequently bc recoverable amounts are greater

testing, exceptions

a dual dated audit report includes 2 dates: 1. date for completion of audit ____________ 2. always later for ____________

litigation

a lawsuit, or intent to start a lawsuit, between a CPA firm and its client -the ability of the CPA firm and client to remain objective is questionable -violation of Rule 200

financial statement disclosure checklist

a questionnaire reminding the auditor of disclosure problems commonly encountered in audits and that facilitates final review of the entire audit by an independent partner

completing the audit checklist

a reminder to the auditor of aspects of the audit that may have been overlooked

review of audit documentation

a review of the completed audit files by another member of the audit firm to ensure quality and counteract bias

operational

a type of audit for any part of an organization's operating procedures and methods for the purpose of evaluating its efficiency and effectiveness -growing audit field: 3 categories: *functional, organizational special* -"*effectiveness*" = accomplishing objectives (i.e. producing parts without defects) -"*efficiency*" = defined as reducing cost without reducing effectiveness -includes sustainability, corporate social responsibility audits

inventory

account that is especially-attractive for misappropriation

fixed assets

account that is often based on subjectively-determined valuation

revenue, AR

accounts with the largest $-value on FS, small change means big changes in other accounts!

State & Federal Securities Act

acts stating that it's a criminal offense to defraud another person by *knowingly being involved w/ false financial statements*

required supplementary info

additional info required by accounting standards

fraud

any intentional deceit meant to deprive another person/party of their property or rights

management

auditing standards say _____________, not the auditor, is responsible for identifying and deciding appropriate accounting treatment for contingent liabilities

subsequent discovery of facts

auditor discovery that the FSs are materially misstated, or that the opinion on internal controls over financial reporting may not have been appropriate, *after* they've been issued

expectation gap

auditors only think they're responsible for auditing in accordance w/ acceptable audit standards; statement users expect auditors to guarantee accuracy of FS and therefore the business's viability

professional

better behavior is expected of you because you're a _____________

US Steel

company published first set of audited financial statements in 1903

unethical behavior

conduct differing from what ppl believe is appropriate given the circumstances

duty, non-negligent, connection

defenses against *Federal* suits: -lack of ______ (depends on jurisdiction) -__________ performance (auditor performed several services according to GAAS) -absence of causal ____________ (typically "non-reliance in 3rd party cases)

earnings management

deliberate actions taken by management to meet earnings objectives

proportional

describe the relationship between accumulated evidence and attained assurance: proportional or inversely-proportional?

interrogative inquiry

determines if person is being deceptive and purposefully omitting facts

short-term liquidity

evaluating going concern includes using these types of ratios: 1. quick ratio 2. current ratio 3. burn rate

corroboration

evidence that confirms or supports a statement, theory, or finding; confirmation.

constructive fraud

extreme or unusual negligence, without intent to deceive or do harm

John B. Stetson Co.

first American corporation to furnish an auditor's certificate when it offered its shares to the public

significant

fraud risks are treated by the auditor as _________ risks

risk

fraud triangle always the same bw misstatements of FS and asset misappropriations, but not fraud _________ factors

comp/prep, limited review, audit

from low to high, order each professional service by the level of assurance required

integrity

impartiality in performing all services, can be interfered with by conflict of interest

current assets

include cash and cash equivalents, accounts receivable, inventory, marketable securities, prepaid expenses.

current liabilities

include short term debt, accounts payable, accrued liabilities and other debts.

fraud

intentional misrepresentation or concealment of a material fact that causes damage to another person

SSARS

issued by the accounting and review services committee of the AICPA, stands for Statements on Standards for Accounting & Review Services

gross negligence

lack of even slight care, tantamount to reckless behavior

tip

most common way of catching a fraud

bank

most typical suit involves __________ loans made, allegedly, by a bank unaware of the insolvency of the creditor bc of misleading FSs (therefore auditor is blamed)

remote, reasonably-possible, probable

name the three levels of review for *contingent liabilities*.

events, procedures

not required by SAS no 132: -auditor responsibility for predicting future ___________ -auditor performance of additional ___________ -specifically states that, even if an entity goes out of business shortly after receiving a clean audit report, this doesn't indicate inadequate audit performance

fraud

occurs when a misstatement is made and there is knowledge of both its falsity AND its intent to deceive

business v audit failure

one reason why lawsuits against CPA firms occur (the other is audit failure v audit risk)

audit failure v audit risk

one reason why lawsuits against CPA firms occur (the other is business v audit failure)

under

parentheses indicates an ____________statement

engagement letters

purpose of these is to outline the exact nature of services to be performed by the CPA --> formalize audit agreements

completing the audit checklist

reminder of items that may have been overlooked in deciding whether the audit evidence is adequate

financial statement disclosure checklist

required by many CPA firms at audit's end

T

T/F: Auditors *generally* have no responsibility to report fraud to outsiders

C

Who is most likely to perpetrate fraudulent financial reporting? A. members of the board of directors B. production employees C. management of the company D. the internal auditors

substantial doubt

if _______________ about going concern exists, auditor must disclose: -principal conditions -possible effects -mgmt's evaluation -possible discontinuance of operations -mgmt's plans -recoverability or classification of recorded assets -amounts/classification of recorded liabilities

going concern

possible definitions for this include: -filed for chapter 11 but expects to maintain operations -doesn't file for reorganization but is incurring annual operating losses -has sold 95% of its operations, yet continues to function -SAS no 132 relies on examples that contradict this assumption: "inability to meet obligations as they become due w/o... ^substantial disposition of assets outside the ordinary course of business, restructuring of debt, externally-forced revisions of operations, or similar actions"

going concern, substantial doubt, going concern, reasonable, effects

requirements of SAS no. 132: 1. to obtain sufficient appropriate evidence regarding mgmt's use of ________________ basis of accounting 2. to conclude, based on the evidence, whether _________________ about an entity's ability to continue as a ______________ for a ______________ period of time exists 3. to evaluate the possible financial statement __________, including the adequacy of disclosure regarding the entity's ability to continue as a going concern for a reasonable period of time 4. to report in accordance with SAS

ethical dilemma

situation a person faces in which a decision must be made about the appropriate behavior (i.e. finding a diamond ring)

T

T/F: you can't provide a service that you'll have to audit later.

quantitative

2 types of analytical procedures addressing fraud include financial and nonfinancial

qualitative

2 types of this method of addressing fraud include SAS 53, Loebbecke, Eining, & Willingham (1988), SAS 99

confidentiality

2nd part of AICPA conduct code, after independence

loss, omission, negligent

*Section 11 under the Securities Act of 1933* treats claims against auditors more favorably than common law. What two things does a plaintiff need to prove to have a case against the auditor of a company in which they purchased new investments? What does the auditor have to do to have the case dismissed? The plaintiff need only prove that: 1. a ________ was suffered by investing in the registered security 2. that the audited financial statements contained a material ___________ or misstatement. The auditor is presumed to have been ___________ unless he or she can prove otherwise.

SEC sanctions

-mean that the SEC can bar a CPA from auditing financial statements of public companies

SLUS (Securities Litigation Uniform Standards Act)

1998 act reducing potential damages in federal securities-related litigation by providing proportional liability in most instances

T

T/F: Fraud is rare and hard to find.

D

The assessment against a defendant of the full loss suffered by a plaintiff regardless of the extent to which other parties shared in the wrongdoing is called: A. separate and proportionate liability. B. shared liability. C. unitary liability. D. joint and several liability.

MiniScribe

-1992 -Coopers & Lybrand had to pay $220mil for deficient audits of the company -company managers materially misrepresented the company's financial status by overstating revenues, understating expenses, counting boxes of bricks as inventory -settled lawsuit for $45mil

RICO (Racketeer Influenced and Corrupt Organization section of the Organized Crime Control Act)

-1970 -list of prohibited offenses originally to target the mafia -abused by plaintiffs to target accountants -those found guilty under RICO had to reimburse plaintiffs for 3x their actual damages

foreign corrupt practices act (FCPA)

-1977 law stating that it's illegal for all domestic US companies and all foreign companies filing with the SEC to *bribe* foreign officials for the purpose of obtaining/retaining business -companies must also have complete and accurate records and adequate internal controls

savings and loan crisis

-1980s financial debacle rivaling the Great Depression -staretd with volatile interest rates of the 70s (led to sharp fluctuations in securities prices) -scandals at ESM Government Securities, Lincoln Savings & Loan -dishonest savings and loan operators: spent billions on junk bonds while manipulating their records to hide losses -US gov spent ~$500bil to close failed businesses

Single Audit Act

-1984 -provides for a single coordinated audit to meet the requirements of all federal agencies -states that entities receiving *more than $750,000* of *federal funds* are subject to *single audits*, even if the funds come from more than one agency

public

-when performing non-audit services for these types of clients, the AICPA code does *not* permit a CPA firm to do both bookkeeping and auditing -unpaid fees -cannot audit own work

PSLRA (Private Securities Litigation Reform Act)

-1995 act reducing potential damages in federal securities litigation by providing for *proportionate liability* in most cases -passed w help from lobbyists -auditors can also protect their reputations/settle lawsuits, stay out of court more -makes them popular targets for settlements out-of-court

Philip Musica

-2x convicted fraudster -changed his name four times, finally to Coster -engaged his brothers to help in the fraud -exploited loopholes to commit a multimillion-dollar fraud at *McKesson & Robbins* (a wholesale drug company) -M&R was actually a shell company that held little inventory and engaged in few real transactions -created customers for it with a "letter-writing plant" called WW Smith -auditors had limited responsibilities -forged sales invoices, shipping documents, inventory records to inflate the profit & assets -led the Institute of Public Accountants to publish its first Statement on Auditing Procedure requiring auditors to observe their clients' physical inventory counts and confirm receivables via direct communication with debtors -fraud uncovered by Julian Thompson -SEC got involved in investigating the financials

Satyam

-3rd-largest software company in India -overstated revenues by $1bil -CEO B Ramalinga Raju -overstated revenues to hide the company's poor operating results ^did this by overstating cash and AR

management representation letter

-4 categories of specific matters to include: 1. financial statements 2. completeness of info 3. recognition, measurement, disclosure 4. subsequent events -auditors required to obtain this in writing from a client, documenting the client's most important oral representations made during the audit -main purposes: ^to emphasize mgmt's responsibility for the financial statements ^to remind mgmt of potential misstatements/omissions (also last chance to tell something they may have hid from us) ^to document responses from mgmt to various audit inquiries -if clients refuse to sign this, auditor must give a qualified/disclaimer opinion -not SUPER important, but is evidence that auditor can later use

Rule 200 (101)

-AICPA Code of Conduct dealing with *independence* -applies to *CPA in public practice* -CPA shall be *independent* in the performance of professional services as required by standards promulgated by bodies designated by council -requires that accountants in pubic practice maintain independence from their clients in both FACT and APPEARANCE -*appearance* = any type of behavior that makes people question your independence as an auditor, i.e. interpersonal relationships (i.e. no happy hours with them!) -prohibits *covered members* of an audit engagement team from owning any *direct investments* in audit clients -*covered members*: -members of the engagement team -members of immediate family -individuals in the position to influence the engagement (i.e. a concurring partner) -a partner/manager who provides non-attest services to the client -partner in the same office as the engagement partner for the client -firm and its employee benefit plans -entity that can be controlled by any of the covered members -*direct investments*: ownership of stock/other equity shares and debt securities by covered members or members of the immediate family (NOT mutual funds)

Rule 320 (203)

-AICPA Code of Conduct rule dealing with *accounting principles* -applies to CPAs in both public and private practice -A member shall follow the professional audit reporting standards promulgated by bodies designated by Council in issuing reports about entities' compliance with GAAP

Rule 400

-AICPA Code of Conduct rule dealing with *acts discreditable* -CPAs from both public and private practice -CPA shall not commit an act *discreditable* to the profession: 1. a crime punishable by imprisonment for more than 1 year 2. The willful failure to file any income tax return that the CPA, as an individual taxpayer, is required by law to filed 3. The filing of a false/fraudulent income tax return 4. The willful aiding in the preparation and presentation of a false and fraudulent income tax return of a client

Rule 600

-AICPA Code of Conduct rule dealing with *advertising and solicitation* -deals with CPAs in public practice -states that the CPA shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading, or deceptive -solicitation by use of coercion, overreaching, or harrassing conduct is prohibited -can only do low-level advertising - no lying (like KFC's "We're the best chicken in the world!" - they're lying.)

Rule 520

-AICPA Code of Conduct rule dealing with *commissions and referral fees* -deals with CPAs in public practice -states that a the CPA shall not for a commission recommend or refer any product/service to be supplied by a client or receive a commission when the member's firm performs an audit, compilation, or examination of financial info for that client -can't refer client to a consulting firm and have that firm pay you back 10% for the referral

Rule 310 (202)

-AICPA Code of Conduct rule dealing with *compliance with standards* -applies to CPAs in both public and private practice -a member who performs auditing, review, compilation, management consulting, tax or other professional services shall comply with standards promulgated by bodies designated by Council

Rule 700

-AICPA Code of Conduct rule dealing with *confidentiality* -deals with *CPAs in public practice* -states that the CPA shall not disclose any confidential client info without the specific consent of the client except for the four specific situations included in the rule: -technical standards -subpoena -peer review (*must be official) -response to ethics division Don't whine about your work publicly.

Rule 510

-AICPA Code of Conduct rule dealing with *contingent fees* -deals with CPAs in public practice -states that the CPA shall not 1. perform for a *contingent fee* any professional services for a client for whom the member's firm performs: a. an *audit* or *review* b. a *compilation* of a financial statement when the member expects them to be used by a 3rd party, without disclosing lack of independence; c. an examination of prospective financial info 2. prepare an *original/amended tax return* or *claim for a tax refund for a contingent fee* for any client

Rule 800

-AICPA Code of Conduct rule dealing with *form of organization and name* -deals with CPAs in public practice -states that a CPA shall not practice public accounting under a firm name that is misleading -A firm can't designate itself as "Members of the AICPA" unless all of its CPA owners are members -i.e. PwC can't call itself "PwC, CPAs" bc not all of them are CPAs

Rule 300

-AICPA Code of Conduct rule dealing with *general standards* -deals with CPAs of both public and private practice -states that the CPA shall comply with the following standards and with any interpretations thereof by bodies designated by Council (*General Standards*): 1. undertake only those professional services that the member can reasonably expect to complete with professional competence 2. exercise due professional care 3. adequate planning and supervision of all engagements 4. obtain sufficient and relevant data to afford a reasonable basis for all conclusions/ Frecommendations

Rule 100

-AICPA Code of Conduct rule dealing with integrity and objectivity -deals with CPAs in both public and private practice -states that, in the performance of any professional service, a CPA: -shall maintain objectivity and integrity, -shall be free of conflicts of interest, and -shall not knowingly misrepresent facts or subordinate his or her judgment to others, including *audit supervisors*

confidential

-AICPA Rule 700: A member in public practice shall not disclose any ___________ client info without *specific consent of the client* -exceptions: obligations related to professional standards, subpoena or summons and compliance with laws and regs (auditors can testify against clients in court), peer review (non-profit clients), response to ethics division

Code of Professional Conduct

-AICPA members agree to follow this code that has 6 principles: 1. responsibilities 2. public interest 3. integrity 4. objectivity & independence 5. due care 6. scope and nature of services -this code is also a conceptual framework to evaluate threats to compliance: 1. identify threats 2. evaluate significance of the threat 3. identify and apply safeguards

Waste Management

-CEO *Dean Buntrock* took over his in-law's business and rebranded it as WMX Technologies in 1993; audit partner involved = *Robert Allgyer* -2 sectors: Waste Management International, Chem Waste -growth marred by allegations of price fixing and illegal trade practices - pressure to perform financially -Nell Minow, head of LENS, a company that specialized in turnarounds, wanted to replace Buntrock and took aim at WMX Tech -company's aggressive accounting practices were a poorly-held secret: exaggerated landfill capacities to stretch amortization of costs like construction, legal fees, inspections, permits -rarely recorded impairment charges -inflated earnings through generous valuations of acquired companies' future cleanup costs ^none of these crimes were known to the auditors, Arthur Andersen (had close ties to the company) -recorded $3.5bil of charges in February to correct prior year misstatements of depreciation expense, capitalized interest, environmental cleanup liabilities, asset impairment losses -auditors had uncovered but failed to report millions of dollars based on company's promise to correct the figures in the future -SEC for the first time since 1985 charged the entire company with fraud -auditors were aware of everything, and at first let the company get away with everything, then got nervous ^Andersen hadn't violated the rules, but had effectively become complicit by allowing the client to continue misstating financials.

WorldCom

-CEO Ebbers, CFO Sullivan, accountant Vinson -fraud uncovered by internal investigation led by Cynthia Cooper ^fraud began by aggressive "tone at the top" led by CEO -telecommunications giant headquartered in MS -collapse of a deal with Sprint marked the end for WorldCom - no more m&a -largest expense = "*line costs*": amounts paid to other phone companies to carry some portion of a WorldCom customer's call -also relied on Arthur Andersen but had to dump them when accounting problems came to light -CFO adjusted revenues, line cost accruals, smoothing of quarterly earnings amounts -capitalized line costs as additions to PPE instead of reporting them as operating expenses -Vinson cooked the books too -accountants had capitalized $3.8bil of line costs as additions to PPE instead of recording the costs as operating expenses

agreed-upon engagements

-CPA ("*practitioner*") agrees on all procedures performed (the responsible party making the assertion and the intended report users also agree) -practitioner expresses neither an opinion nor a conclusion, but *simply reports the results of the procedures that were performed* -intended users of practitioner's report specify the tests and procedures they want performed

lack of privilege

-CPAs don't have the right to withhold info from the courts on the grounds of privilege under common law -certain states permit privileged communication between auditor and client if *they were originally intended to be confidential* -however, doesn't hold up in federal court

SAS 58

-also answers the question: "How do auditors communicate and how can they be more transparent with the board?" -added wording to the intro paragraph of the audit report to clarify the responsibilities of management and the auditor -added scope paragraph describing audit procedures

attestation standards

-also known as Statements on Standards for Attestation Engagements -provide additional guidance for doing attestation engagements -usually don't provide guidance on historical financials, but on all other types of financials

Sunbeam

-Chainsaw Al Dunlap: CEO who had an aggressive approach to business. Feared and despised by his underlings, he was revered on Wall St ^aggressive policies ^wanted to restructure and sell the company, but no company was interested in acquiring it (stock was inflated) -household items -company struggled in the 90s -against Dunlap's wishes, the company released press statement saying earnings would fall short of Wall St's projections - but it didn't release the actual extent of Sunbeam's problems -Donald Kersh: CFO, loyal to Dunlap, creative accountant -channel stuffing -inflation of 1997 revenues and profits -changed its quarter end from March 29-March 31 -auditor Philip Harlow discovered but permitted these shenanigans

FIRREA (Financial Institutions Reform, Recovery, Enforcement Act of 1989)

-Congress tightened regulation of savings and loans thru this act -doubled the minimum net worth requirements of savings and loans, restricting the amounts they could invest in risky assets

quarterly, same, auditors

-FOR *PUBLIC* COMPANIES: SEC requires that _________ financial statements be reviewed by the company's external auditor prior to the company filing of the Form 10-Q with the SEC. -Because the _________ CPA must perform both the annual audit and the quarterly reviews, they are referred to as ___________, not accountants, for the interim review

never

-How many times did the largest % (46%) of auditor respondents to Kelley & Margheim's study say they engaged in audit quality reduction acts?

Parmalat

-Italy's 7th-largest company -dairy company, first produced milk -company's financials had been misstated every year since 1990 -mostly recorded fraudulent transactions on the books of Bonlat Financing Corporation -2003: confessed that its cash balance was overstated by 3.95bil euros

Credit Alliance v Arthur Andersen

-NY state court of appeals -dealt with *foreseen users* -legal case stating the auditor must know and intend that the work product would be used by the 3rd party for a specific purpose and the knowledge and intent must be evidenced by the auditor's conduct

interpretations

-Professional Ethics Executive Committee of the AICPA prepares _____________ based on a consensus of a committee made up principally of CPAs. -these provide scope and rule applications

ordinary

-Recklessness in the case of an audit is present if the auditor knew an adequate audit was not done but still issued an opinion, even though there was no intent to deceive financial statement users. This is the legal term for ______________ negligence -absence of reasonable care -here, accountants will only be liable to *primary beneficiaries*, including known third parties (according to ultramares doctrine)

management's plans

-SAS no 132 directs auditors to consider _____________ for dealing with adverse financial conditions -auditors should seek evidence about whether the adverse condition or event will be mitigated within a reasonable period of time -should talk to mgmt. Don't have to give going concern opinion if mgmt presents an idea for financial success that the auditor approves of -auditor should also consider... ^marketability of the assets that mgmt plans to sell ^restrictions on asset disposal ^assumptions underlying any prospective financial info

substantial doubt

-SAS no 132 doesn't provide any guidance for this term -If an auditor has this about a company's going concern ability, he/she includes an explanatory paragraph in the audit report.

SAB 99

-SEC Staff Accounting Bulletin No. 99: Materiality -not a standard (SEC doesn't issue standards) -nonbinding guidelines for auditors to follow -rejected idea of "bright line rule" for materiality -requires auditors to examine quantitative AND qualitative considerations when evaluating misstatements -forbid companies from recording transactions of any size whose sole purpose was to manage smooth earnings

management letter

-an *optional letter* written by the auditor to the client's mgmt containing the auditor's recommendations for improving any aspect of the client's business -intended to inform client personnel

Rule 2-01

-SEC regulation for auditors of listed (public) companies -states that a relationship between the accountant and the audit client should NOT... 1. pose conflicting/mutual interest between the accountant and the client 2. put the auditor in a position to audit his own work 3. put the auditor in a position to act as an employee or mgmt member of the client 4. put the auditor in a position to act as an advocate of the client -Legislation also prohibits these services: 1. bookkeeping or other accounting services 2. actuarial services 3. investment broker/adviser/banker services 4. HR services 5. legal services outside the audit 6. appraisal/valuation 7. financial info systems design and implementation 8. internal audit outsourcing 9. other PCAOB-prohibited services -requires lead and concurring audit partners rotate off the engagement after 5 years. -limit the practice of CPA firms providing written or oral opinions on applications of accounting principles or the type of audit opinion that would be issued in the event of some hypothetical transaction of an audit client/another CPA firm -ADDITIONAL CONSIDERATIONS: 1. *quality control systems*: If a covered person violates Rule 2-01, but the firm has met certain quality control systems, the firm is safe. 2. *materiality*: Rule 2-01 sections on *employment relationships, contingent fees, and nonaudit services* don't allow for materiality considerations ^rule 2-01 implies that immaterial indirect financial interests in, and business relationships with, an audit client may not impair an auditor's independence 3. *role of audit committee*: SEC encourages registrants to consult with OCA staff on independence issues, and suggests that the audit committee may be involved in the process.

Reg Sox Rule 2-01

-SEC regulation for auditors of listed companies -a relationship between the accountant and the audit client should *not*: 1. create a mutual or conflicting interest between the accountant and the audit client 2. place the accountant in the position of auditing their own work 3. result in the accountant acting as management or an employee of the audit client 4. place the accountant in the position of being an advocate for the audit client

5, time, out

-Sox requires the lead and concurring audit partner rotate off the engagement after ______ years. -Additional SEC regs require a 5-yr "________-________" before recurring -> similar practices elsewhere in the world

Section 404

-Sox section viewed as most unnecessarily burdensome by the business community -requires corporate execs to assess their companies' internal accounting controls every year and attest that the companies have adequate internal control over financial reporting -any material internal control weaknesses must be disclosed in the company's annual report to shareholders -auditors are required to assess and report on the adequacy of their clients' internal accounting controls

Ivar Kreuger

-Swedish financier and playboy (matchmaking) -left construction company Kreuger & Toll to focus on matches -"Savior of Europe" for lending European govts. nearly $400mil after WWI -acquired the rival match company to make the Swedish Match Company -agents used threats and bribery to convince reluctant owners to sell their match factories -offered loans of up to $125mil to governments in return for receving exclusive right to sell matches within the country's borders -raised more than $250mil from Americans by promising to pay dividends as high as 20% per year -committed suicide -ppl couldn't find $115mil of investors' money -required enormous amounts of capital to expand his company - capital he didn't have -$140mil of forged bonds as collateral to borrow more money from Swedish banks -easily kept auditors in the dark by confirming transactions over telegram, speaking in Swedish/other languages at parties, and using dummy phones

GAGAS (Government Auditing Standards)

-The performance of gov audits is regulated by the Government Accountability Office (GAO), who issues the ________________ -sometimes referred to as "*yellow book audits*" -primary source of authoritative literature for doing governmental audits -generally consistent with GAAS, but provide additional guidance on: 1. materiality/significance: thresholds of acceptable audit risk and materiality may be *lower* than in GAAS audits 2. Quality Control: Auditors involved in GAGAS audits must devote at least 24 of the required *80 hours of continuing education* to subjects related to governmental accounting/auditing 3. compliance: Must provide reasonable assurance re: misstatements arising from "noncompliance with provisions of contracts/grant agreements that have a material and direct effect on the FSs" 4. Reporting: Audit report must state that the audit was done in accordance with GAGAS

completeness

-a presentation & disclosure objective -all appropriate disclosures have been included -auditor uses a disclosure checklist to determine if FSs include all disclosures required by accounting standards

occurrence

-a presentation & disclosure objective -disclosed events and transactions have occurred -auditor should review contracts and minutes for key terms, and make sure all financial statements are accurate

Sox

-act stating that attorneys serving public companies must report material violations of federal securities laws by the company ^1st to the CEO and/or general counsel ^if the CEO/GC doesn't respond appropriately, then to the audit committee -ABA amended attorney-client confidentiality rules in response to this requirement to permit attorneys to breach confidentiality if a client is committing a crime/fraud

primary beneficiary

-aka identified user -auditor knows and intends that user will use audit report -ex: auditor is aware of bank loan agreement that requires audited financial statements

foreseeable user

-an unlimited class of users that the auditor should have reasonably been able to foresee as being likely users of the financial statements -ex: a trade creditor that has not previously conducted business with the client. That client hasn't furnished financial statements to trade creditors in the past

SAS 61

-answers the question: "How do auditors communicate and how can they be more transparent with the board?" -auditors must inform the audit committee of significant adjustments

SAS 60

-answers the question: "How do auditors communicate and how can they be more transparent with the board?" -auditors must notify mgmt and the BOD of internal control weaknesses

SAS 54

-answers the question: "WHAT ARE AUDITORS?" -law stating that auditors are responsible for detecting illegal acts that have a direct and material effect on the financial statements -must notify mgmt and the board of any such acts uncovered during the audit

SAS 53

-answers the question: "WHAT ARE AUDITORS?" -one determinant of fraud -qualitative analytical procedure for detecting fraud -includes management, industry, engagement characteristics -provides a list of mgmt risk factors that may contribute to fraud -says that auditors must provide reasonable assurance that material fraud would be uncovered -must look for fraud "red flags" -must report material irregularities to the BOD

SAS 57

-answers the question: "WHAT DO AUDITORS USE?" -auditors must evaluate estimates by reviewing management's process, developing an independent expectation or reviewing subsequent events

SAS 56

-answers the question: "WHAT DO AUDITORS USE?" -states that auditors are required to use analytical procedures during planning and final review stages of audit (look at high-level FSs)

SAS 55

-answers the question: "WHAT DO AUDITORS USE?" -states that auditors must understand and document the client's internal controls

liability for the acts of others

-as auditors, we're liable for the acts of others (i.e. partners responsible for their underlings) -liability for one owner's actions doesn't extend to another owner's personal assets -partners are liable for the work of others on whom they rely under the laws of agency: -employees -other CPA firms -specialists

separate and proportional liability

-assessment against a defendant of that portion of the damage caused by the defendant's negligence -can be increased to 150% of the amount determined to be proportional to CPA's degree of fault when the main defendant is insolvent

joint and several liability

-assessment against a defendant of the full loss suffered by a plaintiff, regardless of the extent to which other parties shared in the wrongdoing -each defendant found guilty of contributing to a plaintiff's losses could be held liable for 100% of the judgment, regardless of the degree of fault (flawed since accountants were often the only solvent defendant following a client's bankruptcy)

compliance

-attestation engagement providing assurance regarding an entity's compliance with specified laws, regulations, rules, contracts, or grants -examples: practitioner issuing an opinion that a borrower has complied with the restrictive covenants of a loan agreement, or a CPA performing agreed-upon procedures to test an oil refinery's EPA compliance -as with prospective info, CPAs (*practitioners*) can perform *examinations* or *agreed-upon procedures*, but *cannot perform reviews* of this. -*examination* report about this must include the word *independent*

privity of contract

-auditor's liability to third parties under common law -provides that a contract doesn't confer rights or impose obligations on anyone except the contracting parties -signed contract where an auditor is liable to the client and can be sued by them/anyone you think would sue them

Phar Mor

-case involving this company -company leased real estate, fixtures, equipment from a company owned by the CEO, COO -paid $800K to a law firm owned by the CEO's brother -leased an airplane from a company owned by the COO -these actions are OK *as long as* the board is ok with them AND the actions are disclosed in the footnotes

Yale Express

-case of understated expense accruals -led to AICPA decision that required the client (and auditor if necessary) to notify financial statement users and SEC if material errors are discovered in a previously-issued set of financial statements

commitments

-closely-related to contingent liabilities -include agreements to purchase raw materials/lease facilities at certain prices/sell merchandise at a fixed price -agreement to commit the firm to a set of future conditions -part of audit for each area of FSs -agreements that the entity will hold to a fixed set of conditions, such as the purchase or sale of merchandise at a stated price, at a future date, regardless of what happens to profits or the economy as a whole

prudent person

-concept stating that the auditor is expected to conduct the audit with "*due care*", not perfection -"...he is liable to his employer for negligence, bad faith, dishonesty, but not for losses consequent upon pure errors of judgment."

internal auditing

-defined as comprising independence, objective assurance and consulting activities designed to add value and improve an org's operations. -Helps an org accomplish objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of *risk mgmt, control, governance processes* -auditors for this are employees of the company and are responsible to mgmt -guidelines provided by IIA: Institute of Internal Auditors (similar to AICPA): published Int'l. Standards for Professional Practice of Internal Auditing

reasonable period of time

-defined in SAS no 132 as "within one year from the date the financial statements are issued - mgmt needs to certify -defined in PCAOB AS 3101 as "not to exceed one year beyond the date of the financial statements being audited"

Treadway Commission

-mission: to identify causal factors leading to fraudulent financial reporting & recommend steps to reduce its incidence

MiniScribe

-desk-drive producer selling 60% of its products to IBM -faced crisis in 1985 when personal computer sales slowed and IBM decided to produce its own disk drives -H&Q invested $20mil to save the company -QT Wiles, aka Dr Fix It, laid off 20% of MiniScribe's workforce and reorganized the remainder into units responsible for specific budgets ^intense pressure to perform financially -inflated sales revenues, inflated net income by understating reserves, fictitious inventory from channel stuffing -put bricks in inventory containers -one auditor was suspicious and ordered the lies to stop, but was struck ill and replaced by another auditor who issued a clean report

Ethics Division

-division of AICPA investigating violations of the code and deciding punishment -less-serious offenses: remedial/corrective action -more serious: Joint Trial Board can expel/suspend CPAs from the AICPA

ultramares doctrine

-doctrine stating that, in cases of *ordinary negligence*, accountants will only be liable to *primary beneficiaries* (have *privity of contract* with the auditor) *and known third parties who are also primary beneficiaries and also have privity of contract* -in cases of *gross negligence*, or fraud, the auditor may be held liable to third parties who *aren't* primary beneficiaries

LS&L (Lincoln Savings & Loan)

-during the savings and loan crisis of the 80s -bankruptcy cost US taxpayers $2.3bil -CEO Charles Keating withdrew $34mil from the company and spent it on political campaigns, junk bonds -auditors did little to constrain his practices - were bribed -Senators whose campaigns he funded stepped in on his behalf when the gov. tried to seize the company

ESM Government Securities

-during the savings and loan crisis of the 80s -managers began buying and selling millions of dollars of treasury bonds, gambling that they could predict when interest rates would rise and fall -ceo Alan Novick concealed $300mil of losses by recording fictitious transactions with an affiliated company -bankruptcy in 1985 -> led to near collapse of Ohio savings and loan system -company's auditor Jose Gomez learned of the fraud in 1979 but allowed it to continue for 5 years while accepting $200,000 of "loans" from ESM execs

Enron

-early 2000s scandal -natural gas company headed by CEOs Ken Lay and Jeff Skilling, and CFO Andy Fastow -enormous capital budget posed a financial dilemma, so the company raised capital thru hundreds of special purpose entities (SPEs) for off-balance-sheet financing ^company could exclude an SPE's assets and liabilities from consolidated financials as long as 3%+ of the SPE's equity was owned by an outside investor ^company broke the rules though ^SPEs mainly controlled by related parties -company marked its energy contracts to "market value" at quarter end -like Waste Management, close ties to Arthur Andersen -convinced the American people and Congress that CPAs had forgotten their responsibility to the public -Arthur Andersen collected $52mil in fees from this company in 2001 -What was Andersen's rationale for declaring the $51mil of known misstatements immaterial, when net income was $105mil? SPEs: should have been consolidated but weren't; nonrecurring charges and "normalized" earnings -Basis for Andersen's conviction on charges of obstruction of justice: auditors not responsible for auditing press releases -> company released press statement. Andersen hadn't approved of the company's earnings announcement due to misleading language in the press release. Andersen then made changes to internal documentation after the earnings announcement went public, to "sanitize the record" -bankruptcy cost jobs of thousands of employees -investors lost $60bil -led directly to Arthur Andersen's collapse

EFCA (Equtiy Fund Corporation of America)

-employees programmed company computers to generate 64,000 phony life insurance policies

liability to clients

-ex: client sues auditor for not discovering a material fraud during the audit -can be based on negligence, gross negligence, or fraud -any significant error creates a *presumption of negligence*

A-133

-federal government guide created by the Office of Management and Budget (OMB) and used in auditing federal assistance and federal grant programs, as well as their respective recipients. -Audit requirements: 1. must comply with GAGAS 2. must obtain sufficient evidence to support a low assessed level of control risk for major programs 3. determine whether the client has complied with laws, regulations, grant requirements, etc. -very detailed -Reporting requirements: 1. opinion on the financial statements 2. opinion on the schedule of federal awards 3. report in internal controls 4. report on compliance with laws, regs 5. schedule of findings and questioned costs

pro forma

-financial info showing what the significant effects on historical financial info might have been had a consummated or proposed transaction or event occurred at an earlier date -for example, a company contemplating a merger with another company might prepare pro-forma financials showing what the consolidated financial position and results of operations would've been in the previous year had the merger already happened -can have a review or examination performed on it

quality control

-firm's system relating to independence that includes both preventitive training (re: independence), and detective (re: inspection) components -protects the firm's independence in case a covered person violates rule 2-01

restatement of torts

-foreseen users must be members of a reasonably-limited and identifiable group of users that have relied on the CPA's work, even though those people weren't specifically-known to the CPA at the time the work was performed

income smoothing

-form of earnings management where revenues and expenses are shifted b/w periods to reduce fluctuations in earnings by reducing inventory or acquired asset values, and amounts of obsolescence for doubtful accounts -aka "cookie jar reserves" used from excesses of underreported income are used in later yrs to offset these later losses

Crazy Eddie

-founded by Eddie Antar -after the fraud was discovered, Antar fled to Israel and eluded police for 2+ years while living off money stashed in secret bank accounts -worked on the fraud with his family -first tried only to avoid taxes, then went to pay skimmed cash to employees under the table -went public with inflated earnings taken from family member bank accounts -stuffed warehouses with hollow boxes to inflate assets -understated liabilities -moved inventory to stores where auditors said they would visit -read auditors papers to prep for any fishy things the auditors mentioned finding -fraud uncovered with the collapse of Eddie's marriage

ZZZZ Best

-founded in 1982 by high school student Barry Minkow (later sentenced to 25 years in prison) -had a market cap of $200mil within 5 yrs -most of the company's purported revenues were fictitious -filed a fictional insurance claim stating that several thousand dollars of equipment had been stolen -altered customers' credit card receipts to overstate charges -submitted duplicate receipts for the same service -a matter of disguising loan proceeds and repayments -- when Barry borrowed money from banks or private investors, he recorded the cash inflows as if they were revenues from customers -when he repaid loans, her recorded the cash outflows as if they were payments for wages and supplies -created a bunch of associated companies to shuffle money around and fool the auditors -wrote script of life story, committed fraud against born-again Christian church

IFAC (International Federation of Accountants)

-founded in Munich in 1977 -supports 4 standard-setting boards who write standards for auditing, ethics, accounting education, public sector accounting

Sunbeam

-home appliance maker that fired CEO "Chainsaw Al" Dunlap and recalled its 1996-7 financials, saying they were materially misstated -auditors had uncovered but failed to report millions of dollars -16% of income came from auditor's proposed adjustments that were never implemented

audit quality reduction

-identified in Kelley & Margheim's 1990 study as 5 potential outcomes of time and budget pressure that directly reduce audit quality -include: 1. prematurely signing off on a required audit step without completing the work or noting the omission of procedures 2. doing less work on an audit step than normally would have been done with more reasonable time budgets 3. failing to research an accounting principle when you were unsure of the answer 4. made tickmarks on audit schedules after an essentially superficial review of supporting documents 5. accepting a client explanation that was weaker than you would have accepted normally, due to tight time budget pressures

underreporting

-identified in Kelley & Margheim's 1990 study as a potential outcome of time and budget pressure that indirectly reduces audit quality -charging time to other clients that should have been charged to the client -shifting chargeable time to non-chargeable categories on your time report -underreporting chargeable time by performing chargeable work on your personal time -mean % of this was highest when the budget was perceived to be *very tight, practically unattainable*

fraudulent activities at MiniScribe

-in Called to Account chs. 18-21 1. Recording of an unordered $9 shipment as a sale 2. Under-recording sales returns by 1,500 3. Recording of FOB destination shipments as sales on date of shipment 4. Recording of nonexistent shipments as sales 5. Breaking into the auditor's trunks to falsify inventory records 6. Over-shipments to customers exceeding $100m 7. Falsifying inventory & sales records 8. Trading of 323,051 shares of MiniScribe stock by senior management while in possession of material nonpublic info

fraud risk factors

-increase risk of fraud -differ bw 2 types of fraud: FS misstatement and asset misappropriation

appearance

-independence in ________________: result of others' interpretations of this independence -sometimes you have to look the part to users as well as play the part

privileged info

-info for which legal proceedings can't require a person to provide the info, even if there's a subpoena -type of info communicated by a client to an attorney or by a patient to a physician

Fund of Funds

-largest mutual fund of Bernard Cornfeld's company, IOS (Investors Overseas Service) -IOS sold mutual funds initially to soldiers stationed abroad -invested in other funds -established a natural resources proprietary account (NRPA), to which John McCandish King (Oklahoma oil king) proposed supplying properties -King committed fraud, betrayed Cornfeld's trust by purchasing inexpensive oil and gas properties, selling them to the NRPA at hugely inflated prices, and inflating their estimated market value to fool investors -King used side agreements to induce people to pay inflated prices for the NRPA's property -auditor Arthur Andersen was aware of this debauchery but chose not to report it -Fund of Funds sued Arthur Andersen for alleging fraud and breach of contract -$81mil judgment against Arthur Andersen

going-concern assumption

-last chance: what you type up. No surprises! -whether there is substantial doubt about a client's ability to continue as a going concern for at least one year beyond the BS date ^auditors address this during planning, but must revisit the assumption in light of evidence collected during audit test work ^if you were on the fence about it, this is when you decide what kind of opinion to give

Securities Act of 1933

-legislation dealing only with companies issuing new securities (only *new* IPOs), i.e. registration statements and prospectuses -"truth in securities" law -primary goal: to ensure that investors received complete and truthful info about securities for sale -"preventative" rather than "punitive" approach: required all public companies to publish a prospectus and registration statement before offering securities to the public -implications for auditor liability: -any 3rd party who purchased securities described in the registration statement may sue the auditor for material misrepresentations or omissions (stressful for auditors) -3rd party users don't have to deal with the burden of proof that they relied on the financial statements or that the auditor was negligent or fraudulent. Users must only prove that the audited financial statements contained a material misrepresentation or omission -the auditor has the burden of demonstrating as a defense that (1) an adequate audit was conducted or (2) all or a portion of the plaintiff's loss was caused by factors other than the misleading financial statements

FDICIA (Federal Deposit Insurance Corporation Improvement Act of 1991)

-legislation raising banks' minimum capital requirements, prescribed standards for loan documentation, prohibition of "excessive" executive compensation -required auditors to examine and report on each bank's internal accounting controls (and later all public companies) -required banks to disclose the FMVs of their monetary assets and liabilities

inventory turnover

-used to measure turnover in evaluating going concern = COGS / avg inventory

SAS 99

-legislation rejecting a bright-line materiality cutoff based on some arbitrary percentage, instead requiring auditors to consider both quantitative and qualitative characteristics of known misstatements in their considerations of materiality ^"brainstorming" sessions to discuss where fraud is most likely to happen -concerns one determinant of fraud (qualitative analytical procedure) -fraud triangle -includes incentives/pressures, opportunities, attitudes/rationalization -replaced (superceded) SAS 82 -states that auditor must... -"brainstorm" fraud risks: auditor must assume risk of material misstatement re: revenue recognition -interview senior mgmt, internal audit, legal counsel, and others about internal procedures to prevent, deter, detect fraud and compare their answers to check for inconsistencies -must perform surprise inventory counts when risk of inventory fraud is high -must perform retrospective review of prior yr accounting estimates -must presume mgmt can override internal controls (auditors always needed to think of how ppl can outsmart internal controls) -must vary audit procedures yr to yr

SOX

-legislation stating that auditors must provide an opinion on the effectiveness of client's internal controls over financial reporting -states that tax services must be preapproved by the audit committee -greatly-increases responsibilities of public companies and their auditors -requires that the lead and concurring audit *partner* rotate off an audit engagement after 5 years -declares it a felony to destroy/create documents (but not fish) to impede/obstruct a federal investigation: Coast Guard case where they ordered fishermen to return illegal fish to port, but the fishermen didn't and the case went to the Supreme Court -Arthur Andersen did this -most dramatic overhaul of nation's financial reporting system since the Securities Acts of 1933 and 34 -tightened auditor independence requirements, assigned new responsibilities to corporate audit committees, required more disclosure of off-balance sheet financing, increased max. prison sentences for fraud, required annual self-assessment by auditors -established a governmental oversight board with authority to write standards and inspect pubic accounting firms to evaluate the quality of their audits

Securities Exchange Act of 1934

-legislation stating that the plaintiff must demonstrate auditor's intent -granted the SEC authority to write financial accounting standards for public companies, who in turn delegated the task of writing detailed rules to the Committee on Accounting Procedure and then the Accounting Principles Board (APB)

Securities Act of 1933

-legislation stating that the plaintiff only has to demonstrate that they suffered a loss -The auditor's intent doesn't matter and reliance on the financial statements is assumed, and does not have to be proven.

inquiry of client's attorneys

-major procedure auditors rely on for evaluating known litigation/other claims against the client and identifying additional ones -letter from the client requesting that legal counsel inform the auditor of pending litigation or any other information involving legal counsel that is relevant to financial statement disclosure -required audit opinion - otherwise, it's a scope limitation and they get a qualified opinion -typically a standard letter, similar to a confirmation -includes... 1. list of pending litigation and asserted/unasserted claims 2. info regarding the progress of each item listed 3. any pending/threatened legal actions not included on the list 4. statement informing the attorney of their duty to inform management of legal matters requiring disclosure and to respond directly to the auditors 5. statement informing the attorney of any unlisted pending or threatened legal actions (or a statement that the client's list is complete) 6. statement informing the attorney of the attorney's responsibility to inform mgmt of legal matters requiring disclosure in the FSs and to respond directly to the auditor

Securities Act of 1934

-many more statements fall under this act than under the 1933 Act -legislation dealing with annual/quarterly filings, 8Ks, etc (basically everything BESIDES new IPOs) -sought to end many abuses common during the 1920s -required *public companies* to file an annual report (*10K*) containing audited financials -established SEC to administer and enforce federal securities laws -*plaintiff's* burden of proof is substantially-higher than under the 1933 Act -*Rule 10b-5*: Plaintiffs including the SEC must show: 1. Manipulation or Deception 2. materiality 3. "in connection with" the purchase or sale of securities; and 4. Scienter - intent to deceive -private plaintiffs have the additional burden of establishing: 5. standing - purchaser/seller requirement 6. reliance; 7. loss causation; 8. damages

related party transactions

-material types of these must be disclosed in the FSs ^includes nature and substance of the relationship, description and amount of the transactions, balances due from or owed to related parties at year end, other relevant info required to comprehend the impact of the transactions on the FSs -some special figures should be included in footnotes for explanation (i.e. Sears explained loan from its CEO)

US Financial

-materially-overstated its 1970-71 net income by recognizing improper gains on bogus "sales" of real estate to affiliated companies -Touche and Ross issued clean audit opinions because they didn't see the fraud -AICPA then issued SAS 6, requiring auditors to perform procedures designed to identify non-arm's-length transactions between clients and affiliated entities

burn rate

-measure of given cash and how long it runs out: good for startups and dying companies -used to measure short-term liquidity in determining going concern -number of months it takes = *operating expenses* (or *SGA expenses*) / 12 months

independence rule

-members in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by the council

covered members

-members of the engagement team -members of immediate family -individuals in the position to influence the engagement (i.e. a concurring partner) -a *partner or manager* who provides non-attest services to the client -partner in the same office as the engagement partner for the client -firm and its employee benefit plans -entity that can be controlled by any of the covered members

Home Loan Industry

-mortgage-backed securities (MBSs) -bonds that pay out the cash flows from a pool of mortgages instead of making fixed coupon and principle payments -for simple MSBs, all interest and principle payments are distributed to the MBS investors each month -more complicated MSBs, which are collateralized, divide the cash flows from the original loans into different *tranches* with the rights to each sold to a different set of investors -*sub-prime lenders*: new breed of mortgage lenders specializing in loaning to low-income borrowers aggressively -led to Dodd-Frank Act that imposed significant changes on the financial services industry, creating the Consumer Financial Protection Bureau to oversee consumer lending transactions ranging from debit and credit card fees to home loan applications ^hedge funds now had to register with the SEC and disclose their trades and contents of their investment portfolios ^2 new federal agencies, Office of Credit Ratings and the Federal Insurance Office

independence of mind

-most important of all auditor's ethical responsibilities -auditor's state of mind permitting the audit to be performed with an unbiased attitude -often aka *independence in fact*

final analytical procedures

-must be done twice (preliminary & final) -preliminary: look for things that stand out, high-level: identify what is important & worth investigating -review for material misstatements or problems not noted during other testing ^ensure that entries for proposed adjustments have been properly applied ^evaluate adequacy of evidence gathered to support unusual account fluctuations ^overall "big picture" review ^may indicate that additional audit evidence is necessary

audit failure

-occurs when an auditor issues an incorrect audit opinion bc the *audit failed to comply with the requirements of auditing standards* (audit failed) -aka problems with the audit that could've been avoided

Role of the Audit Committee

-one additional consideration for Rule 2-01 (the others are quality control services and materiality) -the SEC encourages registrants to consult with OCA staff on independence issues, and suggests that the audit committee may be involved in the process

reasonably-possible

-one level of review for contingent liabilities -footnote disclosure is necessary

remote

-one level of review for contingent liabilities -no disclosure necessary

probable

-one level of review for contingent liabilities -the amount can be reasonably-estimated? Financial statement recognition is necessary -the amount cannot be reasonably-estimated? Footnote disclosure is necessary

completeness of info

-one of 4 categories of matters to include in a mgmt representation letter -includes availability of all financial records and related data, completeness and availability of all minutes of mtgs of stockholders, directors, committees

subsequent events

-one of 4 categories of matters to include in a mgmt representation letter -includes bankruptcy of a major customer, merger or acquisition after the BS date

financial statements

-one of 4 categories of matters to include in a mgmt representation letter -includes mgmt's acknowledgement of its responsibility for fair presentation of financial statements, mgmt's belief that the financial statements are fairly presented

recognition, measurement, disclosure

-one of 4 categories of matters to include in a mgmt representation letter -includes mgmt's belief that the effect of uncorrected misstatements is immaterial (auditor must feel comfortable coming to an agreement w/ the client about what to include), info concerning fraud or related party transactions, unasserted claims/assessments that the entity's lawyer has advised are probable

misappropriation of assets

-one type of fraud -involves theft of an entity's assets -often, the amounts involved are immaterial to the financial statements

fraudulent financial reporting

-one type of fraud: the intentional misstatement or omission of amounts or disclosures, with the intent to deceive users -always material -earnings management *can* be a type of fraudulent financial reporting

direct investments

-ownership of stock/other equity shares and debt securities by covered members or members of the immediate family -materiality not considered here - only in *indirect* financial interests (i.e. mutual funds) -Sox Rule 2-01 implies that immaterial indirect financial interests in, and immaterial indirect business relationships with an audit client may not impair an auditor's independence

review for subsequent events

-post-balance sheet review using auditing procedures required by auditing standards to verify transactions & events occurring after BS date -auditing procedures performed by auditors to identify and evaluate subsequent events; aka *post-balance sheet review*

contingent liability

-potential future obligation to an outside party for an unknown amount resulting from activities already taken place -not always required to be recorded (if the possibility is remote) -3 requirements for existence: 1. potential future payment to an outside party, or impairment of an asset that resulted from an existing condition 2. uncertainty about the amount 3. outcome will be resolved by some future event

unasserted claim

-potential legal claim against a client where the condition for a claim exists but no claim has been filed -violation of a patent agreement that could result in a significant loss to the client if it were known -part of one reason why attorneys won't give out info for fear of being sued themselves

AR turnover

-used to measure turnover in evaluating going concern = total credit sales (or total revenues) / net (or avg) AR

nonpublic

-when performing non-audit services for these types of clients, the AICPA code permits a CPA firm to do both bookkeeping and auditing -can't cut corners on these rules: 1. client must accept full responsibility for the financial statements 2. CPA must not assume the role of employee or mgmt 3. audit must conform to GAAS

prospective financial statements

-predicted/expected financial statements in some future pd (income statement) or some *future date* (balance sheet) -2 types: *forecasts* (expected financial position) and *projections* (financial position given hypothetical assumptions) -general audience: *any third party* -limited: direct audience -in an *examination engagement*, the practitioner expresses an opinion about whether this info conforms to AICPA guidelines and whether the assumptions underlying the forecast/projection are suitably supported -in an *agreed-upon procedure*, the practitioner may be engaged to report the results of it performed on this info -CPAs *can't perform reviews* on this.

debt-to-equity

-ratio used to measure leverage in evaluating going concern = total liabilities / shareholder's equity

debt-to-assets

-ratio used to measure leverage in evaluating going concern = total liabilities / total assets

foreseen user

-reasonably limited and identifiable group of users who have relied on the auditor's work -ex: bank or trade creditors when the auditor is aware that the client has provided audited financial statements to such users

reasonable period of time

-relevant for going concern -defined by *SAS no 132* as the period of time required by the applicable financial reporting framework or, if no such requirement exists, *within one year after the date that the financial statements are issued* (or available to be issued)

SAS 82

-replaced ("superseded") SAS 53, as a clarification to be taken more seriously than SAS 53 and have more explicit language -states that auditors must plan and perform the audit to obtain reasonable assurance about whether the FSs are free of material misstatement, whether caused by error or fraud

SAS 16

-required auditors to search for material errors and irregularities

compilation

-service engagement defined in SSARS as one in which accountants apply accounting and financial reporting experience to assist management in the preparation of financial statements and issue a report to a client or third party without providing any CPA assurance about the statements -prepared by a CPA -no analytical procedures/testing/assurance provided here -3 types: 1. compilation with full disclosure (requires accordance with accounting standards) 2. compilation omitting substantially all disclosures (acceptable if the report indicates lack of disclosures; their absence doesn't seem intentional) 3. compilation without independence from client (last paragraph must state this dependence) ^use of each depends on whether mgmt elects to include all required disclosures with the financial statements and whether the accountant is independent -requirements: 1. establish an understanding with the client 2. possess knowledge about the accounting principles and practices of the client's industry 3. know the client, nature of its business transactions, accounting principles, practices, financial statement content 4. make inquiries to determine whether the client's info is satisfactory 5. read the compiled financial statements and be alert for any obvious omissions/errors 6. prepare documentation in sufficient detail to provide a clear understanding of the work performed and any findings/issues that are significant 7. request mgmt to revise the financial statements, if the accountant becomes aware of needed revisions

SOC

-service org. report -3 types: 1. SOC 1: report on controls at a service org. relevant to User Entities' Internal Control over financial reporting: services auditors follow attestation standards; user auditors follow user auditor standards -types of reports on controls that service auditors normally issue: report on mgmt's description of a service org's system and the suitability of the design & operating effectiveness of controls (auditor reports on suitability and fairness of controls) 2. SOC 2: ethics of processing user data and confidentiality/privacy 3. SOC 3: similar to SOC 2 but intended for wide distribution to current/potential users as a service org and as a marketing tool for demonstrating that they have good controls

profession

-specialized body of knowledge -formalized admissions requirements -code of ethics -public service

OCA

-stands for office of the chief accountant -as an additional consideration of Rule 2-01, the SEC encourages registrants to consult with the staff of this office on independence issues and suggests that the audit committee may be involved in the process

direct effect

-subsequent events having a direct effect on the financial statements, that require adjustments 1. ie declaration of bankruptcy by a customer w/ an outstanding balance 2. settlement of litigation at an amount different from the accrued amount 3. disposal of equipment at a price below book value 4. sale of investments at a price below cost

non direct effect

-subsequent events that don't have a direct effect on the financial statements but are significant enough to require disclosure -i.e.: What auditor should reasonably expect to be included in a report. 1. a decline in the market value of securities held for temporary investment or resale 2. issuance of bonds/equity 3. decline in market value of inventory as a consequence of government action barring further sale 4. uninsured loss of inventories 5. merger or acquisition

unadjusted misstatement audit schedule

-summary of immaterial misstatements not adjusted at the time they were found; used to help the auditor assess whether the combined amount is material -aka *summary of possible misstatements* -if auditors believe there's sufficient evidence, but conclude that financial statements are inaccurate, they have 2 choices: 1. statements must be revised; 2. qualified/adverse opinion is issued

audit risk

-the possibility that the auditor concedes, after conducting an *adequate audit*, that the financial statements were fairly stated when, in fact, they were materially-misstated -aka unavoidable--*inherent risk*

BarChris Construction Corporation

-went bankrupt -incorrectly accounted for several construction projects and auditor Peat Marwick had failed to exercise due diligence in reviewing the S-1 registration statement -led the AICPA to provide additional guidance on procedures auditors should perform when reviewing events subsequent to BS date -led accounting firms to place greater emphasis on making sure auditors understand the client's business and industry

subsequent events

-transactions and other pertinent events that occurred after the *balance sheet date*(but before audit report) that affect the fair presentation/disclosure of the statements being audited -3rd part of the audit -audit procedures typically used to identify this include: ^cutoff and valuation tests performed during the normal course of audit test work ^review of JEs and ledgers for significant transactions after BS date ^review of internally-prepared FSs ^minutes of BOD meetings ^correspondence w/ attorneys ^inquiries of mgmt and letters of representation -2 types of this include direct and non direct effect, both require mgmt's consideration, auditor's evaluation, disclosure.

lack of duty

-type of defense against client suits -COA firm claims that there was no contract between the CPA and the client -> miscommunication of expectations

non-negligent performance

-type of defense against client suits -auditor performed services according to GAAS (hard to prove)

contributory negligence

-type of defense against client suits -client's own actions resulted in the loss or interfered with the audit such that it prevented the auditor from discovering the cause for the loss -ordinarily unavailable to auditors when 3rd parties are involved - latter can't speak on financial statement accuracy

absence of causal connection

-type of defense against client suits -loss was not the result of the auditor's actions -hard to prove bc users may claim reliance on statements w/o considering company's financial condition when they lent it money

fraudulent financial reporting

-type of fraud -for *inventory*, includes: -fictitious inventory -overstated inventory valuation -warning signs: analytical procedures like *GP* and *inv. turnover*

misappropriation of assets

-type of fraud -for *inventory*, includes: -theft of inventory -warning signs: analytical procedures like *GP %* and *inv turnover*

misappropriation of assets

-type of fraud -for *payroll*, includes: -fictitious employees -overstatement of labor hours -warning signs: analytical procedures like *salary expense %* and *labor variance*

fraudulent financial reporting

-type of fraud -for *payroll*, includes: -improper capitalization of labor costs -warning signs: analytical procedures like *salary expense %* and *labor variance*

fraudulent financial reporting

-type of fraud -for *revenues*, includes: -fictitious revenues, premature revenue recognition, bill and hold sales, Xerox, Bausch & Lomb (channel stuffing) -manipulation of adjustments (sales returns & allowances, allowance for doubtful accounts) -warning signs: analytical procedures like *Gross Profit*, *AR Turnover*, *document discrepancies*

misappropriation of assets

-type of fraud -for *revenues*, includes: -theft of cash/failure to record a sale -theft of cash AFTER a sale is recorded (record a return, write off the receivable, or lapping) -warning signs: analytical procedures such as *declining margins* and *document discrepancies*

Loebbecke, Eining, Willingham

-type of quantitative analytical procedure that developed a framework for evaluating fraud risk and providing primary/secondary indicators

financial

-type of quantitative analytical procedure that involves building an expectation of an account balance and comparing it to the actual one

nonfinancial

-type of quantitative analytical procedure that involves company- and situation-specific measures

preparation

-type of service engagement where the CPA, who prepares it, is engaged by the client to prepare or assist in preparing financial statements, but the CPA doesn't provide any assurance on the financial statements or issue a report -CPA's responsibilities are similar to those in a compilation, except for the letter and the *assessment of independence* -is a no-attest service, so the CPA doesn't need to determine whether he/she is independent -CPA doesn't issue a report or assess independence -CPA ensures each paragraph of financials that he provides says "*no assurance is provided*", or at least issues a disclaimer or performs a compilation services if he can't include this statement

dual-dated audit report

-use of one audit report date for *normal subsequent events* and a later date for *one or more subsequent events* that come to the auditor's attention *after the date of the audit report* ^restrict the subsequent event tests to matters related to the event in question and issue a *dual-dated* audit report -other option in this situation is for the auditor to expand all subsequent event tests out to the new date and prepare a new audit report

National Student Marketing Corp

-used controversial accounting technique called "*pooling of interests*" to increase revenues from less than $1m to $68m in the 60s

assessment inquiry

-used to corroborate or contradict prior info by starting w/ broad questions and working toward narrower ones

gross profit %

-used to measure profitability in evaluating going concern = GP (sales - cogs) / sales

RoA (return on assets)

-used to measure profitability in evaluating going concern = NI (or loss) / total assets

RoE (return on equity)

-used to measure profitability in evaluating going concern = NI / shareholder's equity

quick ratio

-used to measure short-term liquidity in determining going concern -aka acid test ratio = (current assets - inventories) / current liabilities OR (cash + short-term investments + current receivables) / current liabilities ?

current ratio

-used to measure short-term liquidity in determining going concern = current assets / current liabilities

IAASB (International Auditing and Assurance Standards Board)

-writes the auditing standards internationally -18 voting members -follows a rigorous due process in developing International Standards on Auditing (ISAs) -2/3 of IAASB members must approve a proposed standard before it's adopted

audit

. A(n) ________ failure occurs when an auditor issues an erroneous opinion because it failed to comply with requirements of auditing standards.

Kelley & Margheim

1990s study identifying 6 potential outcomes of time and budget pressure that either directly or indirectly reduce audit quality: -*indirect*: underreporting of audit time -*direct*: -prematurely signing off an audit program step -reducing amount of work done on an audit step below what the auditor would consider reasonable -failing to research an accounting principle -making superficial reviews of client documents -accepting weak client explanations

selfishly

2 primary reasons why ppl act unethically: 1. person's ethical standards differ from society's 2. person chooses to act ___________

entries, estimates, rationale

3 Procedures performed in every audit to address mgmt override of controls: -examine journal _________ & other adjustments for evidence of possible misstatements due to fraud -review accounting __________ for biases -evaluate business __________ for significant unusual transactions

engagements

3 levels of ___________ & related forms of conclusions: 1. examinations 2. reviews 3. agreed-upon procedures

overall, assertion, management

3 levels of responses to fraud risk: 1. ______ responses 2. responses at the ________ level 3. responses related to __________ override

purpose, distribution, nonfinancial

3 main differences bw operational and financial auditing: -_____________ of the audit -_____________ of the reports -inclusion of ___________ areas in operational auditing

full disclosure, omitting, independence

3 types of compilation reports: 1. compilation with ________________ (requires accordance with accounting standards) 2. compilation ___________ substantially all disclosures (acceptable if the report indicates lack of disclosures; their absence doesn't seem intentional) 3. compilation without _____________ from client (last paragraph must state this dependence) ^use of each depends on whether mgmt elects to include all required disclosures with the financial statements and whether the accountant is independent -these reports require the following: 1. date of the accountant's report is the date of completion of the compilation 2. each page of the financials compiled by the accountant should state "See Accountant's Compilation Report" 3. if client fails to follow accounting standards, auditor must include the same modifications as in a review report

C

34. Which of the following is an illustration of liability under the federal securities acts? A. Client sues auditor for not discovering a theft of assets by an employee. B. Bank sues auditor for not discovering that borrower's financial statements are misstated. C. Combined group of stockholders sue auditor for not discovering materially misstated financial statements. D. Auditor sues client for not cooperating during engagement.

confidentiality

4 exceptions to this include: 1. obligations related to technical standards 2. subpoena/summons and compliance with laws & regs (aka privileged info) 3. peer review: CPA and the firm conducting a peer review of the quality controls of another CPA firm, it's normal practice to examine several sets of audit files 4. response to ethics division

clients, common, civil, criminal

4 types of auditor's legal liability: 1. liability to ________ 2. liability to 3rd parties under _______ law 3. _________ liability under federal securities laws 4. _________ liability

programs, responsibility, oversight

AICPA's 3 elements to detect & deter fraud: 1. culture of honesty and high ethics --> antifraud ____________ and controls 2. mgmt's ___________ to evaluate fraud (Tone at the Top) 3. audit committee __________

T

AICPA code permits a CPA firm to do both bookkeeping and auditing for a nonpublic audit client as long as... -client accepts full responsibility for financial statements -CPA doesn't assume role of employee/mgmt -audit conforms to GAAS ^auditor/client can't skip steps or cut corners

D

After issuance of the auditor's report, the auditor has no obligation to make any further inquiries with respect to audited financial statements covered by that report unless: A. A final resolution of a contingency that had resulted in a qualification of the auditor's report is made. B. A development occurs that may affect the client's ability to continue as a going concern. C. An investigation of the auditor's practice by a peer review committee ensues. D. New information is brought to their attention concerning undisclosed related party transactions of the previously audited period.

T

T/F: Sox Rule 2-01 states that the SEC encourages registrants to consult with OCA staff on independence issues, and suggests that the audit committee may be involved in the process

T

T/F: The Big Four aren't really global companies--they're consortiums of legally-distinct companies who cooperate to serve multinational clients

procedures, management, assess, explanatory paragraph

Discuss the steps used by an auditor to evaluate an entity's ability to continue as a going concern: 1. Consider whether the results of audit ____________ performed during the planning, performance, and completion of the audit indicate whether there is substantial doubt about the entity's ability to continue as a going concern for a reasonable period of time (one year). 2. If there is substantial doubt, the auditor should obtain information about _______________'s plan to mitigate the going concern problem and ________ the likelihood that such plans can be implemented 3. If the auditor concludes, after evaluating management's plans, that there is substantial doubt about the ability of the entity to continue as a going concern, he or she should consider the adequacy of the disclosures about the entity's ability to continue and include an _____________ ______________ in the audit report.

B

On the basis of audit evidence gathered and evaluated, an auditor decides to increase the assessed level of risk of material misstatement from that originally planned. To achieve an overall audit risk level that is substantially the same as the planned level of acceptable audit risk, the auditor would A. Decrease amount of substantive testing B. Decrease detection risk C. Increase detection risk D. Increase materiality levels

1

SEC interpretations say independence is impaired if billed/unbilled fees remain unpaid for professional services provided by _________+ years before the report date

prohibited services

SEC says these aren't allowed for public audit clients: 1. bookkeeping and accounting 2. financial info systems design and implementation 3. appraisal/valuation services 4. actuarial services 5. internal audit outsourcing 6. management or human resource functions 7. broker/dealer/investment adviser/investment banking services 8. legal/expert services unrelated to the audit 9. other PCAOB-prohibited services

materiality

Sections of 2-01 related to employment relationships, contingent fees, non-audit services don't allow for considerations of __________. -Rule 2-01 implies that *immaterial indirect financial interests in, and immaterial indirect business relationships with a client, may not impair an auditor's independence*

public, material fraud, SEC, 3, auditor

Securities Reform Act of 1995: -legislation only applying to audits of _______ companies -if auditor discovers ________, auditor must report it to client's BOD -BOD must notify the ________ within ______ business days and send a copy of the notification to the auditor -if the client doesn't notify the SEC, the __________ must do so.

T

T/F: According to Kelley & Margheim's study, the mean # of audit quality reduction acts was highest when the budget was perceived to be very tight, practically unattainable.

T

T/F: Although the AICPA allows accountants to co-contract with their audit clients as long as the revenues aren't material to the auditor, the SEC forbids direct business relationships between public accounting firms and their publicly-traded audit clients

T

T/F: Audit fees are determined based on negotiations between the audit firm and the client. They are based on how much work the audit will require, how risky it is, etc.

T

T/F: Audit partners & managers providing 10+ hours of nonaudit services to the client and partners in the office of the partner primarily responsible for the audit engagement are NOT independent

T

T/F: Auditing Standards (SAS No. 59) requires auditors to evaluate whether there is a substantial doubt about a client's ability to continue as a going concern.

T

T/F: Auditors are especially concerned with these types of liabilities: -pending litigation for patent infringement, product liability, etc. -income tax disputes -product warranties -notes receivable, discounted -guarantees of obligation of others -unused balances of outstanding letters of credit

T

T/F: CPAs are prohibited from receiving commissions for a client who is receiving attestation services from the CPA firm - but they're permissible for other clients as long as they're disclosed

T

T/F: Clients can recover damages from auditors for breach of contract, negligence, or fraud

F

T/F: Every contingent liability must be recorded.

T

T/F: For review services engagements, CPAs must be *independent* of the client

T

T/F: For review services engagements, accountants don't obtain an understanding of internal control, test controls, assess fraud risk, or do substantive tests of transactions/tests of balances

T

T/F: For review services engagements, suggested procedures include *inquiries of mgmt and analytical procedures* -> substantially-fewer than those required for an audit

T

T/F: Internal and external auditors can work together.

T

T/F: Internal and external auditors report to different boards (mgmt and FS users, respectively), but both are responsible for competence, objectivity, and consideration of risk & materiality

T

T/F: Internal auditors are responsible to mgmt while external auditors are responsible to financial statement users

T

T/F: Internationally, the most important ethical standards are published by the International Ethics Standards Board for Accountants

T

T/F: Once the financial statements have been issued, the auditor doesn't have to update a resolved contingency that contained disclosure of the contingency in the footnotes based on info from the issuance date. It's only if it happens before the audit report is signed.

T

T/F: Sox Rule 2-01 implies that immaterial indirect financial interests in, and immaterial indirect business relationships with, an audit client may not impair an auditor's independence

T

T/F: The U.S. Government Accountability Office (GAO) issues Government Auditing Standards (GAGAS). The financial auditing standards within GAGAS are consistent with the principles of the AICPA auditing standards. However, GAGAS contain additional standards and modifications related to the following: -Materiality and significance -quality control -compliance auditing -reporting

T

T/F: The independence standards issued by the PCAOB do not prohibit the provision of tax services to an attest client.

T

T/F: The most common act of audit quality reduction committed by auditor respondents to Kelley & Margheim's study was accepting a client explanation that was weaker than you would have accepted normally, due to tight time budget pressures

T

T/F: The only procedures done in a review are inquiries and analytical tests

T

T/F: Under common law, auditors are liable to third parties for gross negligence and fraud, but not ordinary negligence.

T

T/F: auditor is liable to third parties, including investors, vendors, customers, creditors (i.e. lending institutions like banks)

T

T/F: auditor is responsible for reviewing for subsequent events up to, but no later than, the audit report date

T

T/F: auditor's responsibility is to plan the audit with professional skepticism

T

T/F: confirmation, reperformance, recalculation objectives used less-extensively for operational audits since the existence/completeness objectives aren't usually relevant

T

T/F: generally loans bw CPA firm or covered members and an audit client are prohibited, and so are jointly-held investments or high-up employee positions with the client!

T

T/F: in the early 20th century, public accountants welcomed legal liability as a means of promoting higher-quality audits and disciplining negligent/dishonest auditors

T

T/F: individual auditors can protect themselves against liability by... -dealing only w/ clients possessing integrity -maintaining independence -healthy professional skepticism -understanding client's business -performing quality audits -properly-documenting work -exercising professional skepticism

T

T/F: info obtained from a client to a CPA is NOT privileged

T

T/F: most companies try to fraudulently overstate income, but some try to understate it

T

T/F: of the AICPA's 3 elements to detect and deter fraud, antifraud programs and controls are the MOST EFFECTIVE at dealing with fraud

T

T/F: only the state can take away a CPA license.

T

T/F: operational audits have more diversity than financial audits

T

T/F: sometimes auditors prepare statements on bases other than GAAP or IFRS, such as the cash/modified cash basis, basis used to comply w/ requirements of regulatory agency, income tax basis, financial framework for small/medium-size businesses, definite set of criteria having substantive support

manipulations of adjustments to revenues, fictitious revenues, premature revenue recognition (bill-and-hold sale)

What are the three main types of revenue manipulations employed to commit *fraudulent financial reporting* and give an example for each type?

A (severe scope limitation)

When a client will not permit inquiry of outside legal counsel, the audit report will ordinarily contain a(n): A. disclaimer of opinion. B. qualified opinion. C. standard unqualified opinion. D. unqualified opinion with a separate explanatory paragraph.

dual dated

When a significant event occurs after the report date but prior to filing, the auditor can . . . -extend all subsequent event tests out to the new date, and prepare a new audit report, OR -restrict the subsequent event tests to matters related to the event in question and issue a _____________ audit report (part of a letter of representation)

D

When an auditor concludes there is substantial doubt about an entity's ability to continue as a going concern for a reasonable period of time, the auditor's responsibility is to: A. Prepare prospective financial information to verify whether management's plans can be effectively implemented. B. Project future conditions and events for a period of time not to exceed one year following the date of the financial statements. C. Issue a qualified or adverse opinion, depending upon materiality, because of the possible effects on the financial statements. D. Consider the adequacy of disclosure about the entity's possible inability to continue as a going concern.

D

Which of the following subsequent events will be least likely to result in an adjustment to the financial statements? A. Culmination of events affecting the realization of accounts receivable owned as of the balance sheet date B. Culmination of events affecting the realization of inventories owned as of the balance sheet date C. Material changes in the settlement of liabilities which were estimated as of the balance sheet date D. Changes in the quoted market prices of listed trading securities since the balance sheet date

C

Which of the following would the auditor expect to find in the client's management representation letter? A. management's recommendations for internal control effectiveness improvements B. management's plans for improving product quality C. management's compliance with contractual arrangements that impact the financial statements D. management's goals for improving earnings per share

B

Which statement is correct concerning an auditor's statutory legal liability? A. The Securities Act of 1933 broadened the auditor's common law liability and the Securities Exchange Act of 1934 narrowed it B. The auditor has a greater burden of defense under the Securities Act of 1933 than under the Securities Exchange Act of 1934 C. Criminal liability only arises under state law D. Statutory liability usually modifies the auditor's liability to the client

B

Which statement is correct concerning an auditor's statutory legal liability? A. The Securities Act of 1933 broadened the auditor's common law liability and the Securities Exchange Act of 1934 narrowed it B. The auditor has a greater burden of defense under the Securities Act of 1933 than under the Securities Exchange Act of 1934 C. Criminal liability only arises under state law D. Statutory liability usually modifies the auditor's liability to the client

forseeable user

any users that the auditor should have reasonably been able to foresee as likely users of the financial statements have the same rights as those with privity of contract (i.e. unlimited class)

doubt, alleviated

auditors must document 2 major conclusions about going concern in the workpapers: 1. conclusion that substantial _______ exists about entity's ability to continue as a going concern 2. conclusion that substantial doubt is ___________ because of mgmt's plans

duty, non-negligent

defenses against *third party suits* include: -lack of ___________: depends on t he interpretation of "foreseen user" -___________ performance: auditor performed services according to GAAS -absence of ___________ connection: typically "non-reliance" in 3rd-party cases -you didn't rely on the financial statements in the 1st place so it's unrelated -timing issue: prove nonreliance that way

opinion shopping

firm considering hiring an auditor asks the auditor about a sketchy/illegal thing the firm may want done (the auditor is eager to be hired, so will be tempted to say something equally sketchy/illegal and therefore implying a willingness to participate in this hypothetical crime)

comp/prep, limited review, audit

from low to high, order each professional service by amount of evidence accumulated