Audit: Ch. 10, 11, 12, 16, 17

Why do we spend so much time auditing cash?

-High inherent risk -Temptation to steal -Virtually all transactions eventually flow through the cash acct

Review of the Engagement

-Review of work of audit staff accomplished through review of audit working papers -Typically performed by seniors -Review of working papers not completed until near (of after) completion of fieldwork -Partner and manager devote attention to accounts with higher risk of material misstatement -Second partner review prior to issuance of audit report

PCAOB Standard Report (differences from AICPA)

-includes the word "registered" in the title -references standards of PCAOB rather than GAAS -includes an additional paragraph indicating that the auditors have also issued a report on the client's internal control over financial reporting (**Other differences that no longer apply: doesn't include section headings, includes less detailed discussions of mgt and auditor responsibilities)

Substantive Procedures for Accounts Receivable

-obtain an aged listing of receivables and reconcile to ledgers -obtain analyses of notes receivable and related interest -inspect notes on hand and confirm those not on hand -confirm receivables with debtors -review the YE cutoff of sales transactions -perform analytical procedures -review significant YE sales contracts for unusual terms -verify interest earned on notes receivable -evaluate the propriety of client's accounting for transactions -evaluate accounting estimates related to revenues -determine adequacy of allowance for uncollectible accounts -ascertain the existence of pledged receivables -investigate receivables from related parties -evaluate the business purpose of significant and unusual sales transactions -evaluate financial statement presentation and disclosure

Key Substantive Procedures for Cash (Tests of Balances)

-obtain analyses of cash balances and reconcile to general ledger -confirm cash balances with financial institutions -obtain reconciliations of bank accts ( as of b/s date) and consider the need to reconcile bank activity for additional months -obtain bank cutoff statement (of at least 7 business days after b/s date) -count & list cash on hand -verify cutoff for cash transactions (receipts and disbursements) -analyze bank transfers occurring year-end (last week of audit year, 1st week of next year) -investigate payments to related parties (checks for large or unusual payments) -evaluate proper financial statement presentation & disclosure of cash -reperform/test the clerical accuracy of reconciliations; tie out to confirmations

Purchase and Production Cycle

-purchasing -receiving -storing -issuing -processing -shipping

External Confirmations

Audit evidence obtained by the auditors as a direct written response to the auditors from a third party (the confirming party) in paper form or by electronic or other medium

Kiting

Manipulations causing an amount of cash to be included simultaneously in the balance of two or more bank accounts

Bill and Hold Transactions

Transactions in which sales of merchandise are billed to customers prior to deliver, with the goods being held by the seller

Management Letter

a communication that provides a summary of auditors' recommendations resulting from the audit engagement that allows the client to improve the effectiveness and efficiency of its operations *includes suggested adjustments the auditor thinks should be made as a result of potential misstatements (known or likely misstatements)

Job Time Ticket

a document designed to accumulate the labor and machine time devoted to a particular production order

Bill of Lading

a document issued by a common carrier acknowledging the receipt of goods and setting forth the provisions of the transportation agreement

Disclaimer Opinion

a form of report in which the auditors state that they do not have express an opinion on the f/s (typically due to very significant scope limitations)

Letter of Inquiry

a letter sent by auditors to a client's legal counsel requesting a description and evaluation of pending or threatened litigation, unasserted claims, or other loss contingencies *prepared by mgt, sent by auditors (returned letter from counsel is referred to as lawyer's letter)

Loss Contingencies (Contingent Liabilities)

a possible loss stemming from past events that will be resolved as to existence and amount by some future event auditors should: -determine the existence of any (systematic search is usually required b/c of lack of documentation in accounting records) -appraise probability that a loss has been incurred and its amount **probable & reasonably estimable require disclosure and adjusting entry (book it) -if only reasonably possible disclose, ignore if remote -contingent assets, don't book until basically received

Confirmation Request

a request sent to a confirming party requesting that the confirming party consider the accuracy of information included in that request; may be a positive or negative confirmation request by obtaining written acknowledgement of the debt by the debtor, the auditors obtain audit evidence that helps - establish the existence and gross valuation of the asset -provides some assurance that no lapping or other manipulation affecting receivables is being carried on at the b/s date

Review of Meeting Minutes

auditors should review the minutes of meetings of stockholders or the BOD; should review all minutes including those meetings subsequent to YE; also obtain written confirmation that management made all meeting minutes available

Materials Requisitions

records of materials used in particular jobs; part of the documentation of the flow of goods and related responsibility as they go through the production process

Unqualified (unmodified) Opinion

the opinion expressed by the auditors when they conclude that the financial statements are prepared, in all material respects, in accordance with the applicable reporting framework (i.e. GAAP)

search for unrecorded liabilities

Procedures designed to detect liabilities that existed at YE but were omitted from the liabilities recorded in the audit client's financial statements

Documents Used in a Voucher System

-Purchase Order -Receiving Report -Vendor Invoice

Documents Used in a System of Internal Control

-Purchase Order -Sales Order -Bill of Lading -Invoice -Control listing -Credit Memo

Analytical Procedures for A/R, Notes Receivable, & Revenue

-gross profit rate (by store, product line, or region) -ratio of sales in the last week or month to total sales for the quarter or year -revenue in relation to productive capacity -A/R turnover -the ratio of a/r to the year's net credit sales -the ratio of accounts written off during the year to the end bal of a/r -the ratio of returns and allowances to sales -the ratio of interest revenue to notes receivable -the ratio of uncollectible accts expense to credit sales

Standard Report: Form/Content

-has a title that includes the word "independent" -addressed to those for whom it is prepared (i.e. audited company itself or those in charge of its governance -divided into sections with headings (after introduction) -introductory paragraph identifies the f/s that have been audited -"management's responsibility for the financial statement": indicates that mgt is responsible for the preparation and fair presentation of f/s in accordance with GAAP & responsibility for internal control -"auditors responsibility": (1) indicate that it is auditor's responsibility to express an opinion on f/s based on an audit conducted in accordance with GAAS (2) outline the nature of an audit (3) conclude that the auditors believe that sufficient appropriate audit evidence has been obtained ot provide a basis for an audit opinion -"opinion": presents auditor's opinion on whether f/s are prepared fairly and in accordance with GAAP -report signed with the name of the CPA firm, not an individual partner -the report should not be dated earlier than the date at which the auditors have obtained sufficient appropriate audit evidence to support their opinion

Potential Misstatements: Inventory

-misstatement of inventory costs -misstatement of inventory quantities -early/late recognition of purchases ("cutoff problems")

Potential Issues with Inventory

-obsolescence -slow moving inventory -FIFO/LIFO costing -lower of cost or market (LCM)

Substantive Procedures: Inventory/CGS

-obtain listings of inventory and reconcile to ledgers -evaluate the client's planning of physical inventory *-observe the taking of the physical inventory (cutoff; select last shipping/receiving documents) -review the YE cutoff of purchase and sales transactions *-obtain a copy of the completed physical inventory & test its accuracy (test counts: existence, completeness, accuracy) -evaluate the bases and methods of inventory pricing *-test the pricing of inventories (valuation) *-perform analytical procedures -determine whether any inventories have been pledged and review commitments -evaluate financial statement presenation and disclosure

Procedures Completed at the End of the Audit

-search for unrecorded liabilities -review the minutes of meetings -perform final analytical procedures -perform procedures to identify loss contingencies (legal review and legal letters) -perform the review for subsequent events -obtain the representation letter

Controls Over Cash

-segregation of duties: don't let one employee handle a transaction from beginning to end -segregation of duties: separate cash handling from record keeping -centralize receiving of cash to the extent practical -encourage customers to obtain receipts; observe register totals -deposit cash receipts daily -make all disbursements by check or EFT (rather than with cash) -perform bank reconciliations monthly -monitor cash receipts/disbursements by comparing to budget/forecasted amounts

Standard Report CANNOT be Issued When...

-there are conditions (but not departures) from GAAP, about which the reader of the f/s should be informed -material departures from GAAP in the audit client's f/s -auditors are unable to obtain sufficient appropriate audit evidence

Revenue Cycle

1. preparation of the sales order 2. credit approval 3. issuance of the merchandise from stock 4. shipment 5. billing 6. invoice verification 7. maintenance of control accounts 8. maintenance of customers' ledgers 9. approval of sales returns and allowances 10. authorization of write offs of uncollectible accounts

Aged Trial Balance (Accounts Receivable)

A listing of individual customers' accounts classified by the number of days subsequent to billing (that is, by age); a preliminary step in estimating the collectability of accounts receivable **considerations made for allowance for doubtful accounts; support the balance prepared by the audit client

Emphasis of a Matter Paragraph

A paragraph included in the auditor's report that is required by GAAS or is included at the auditor's discretion and that refers to a matter appropriately presented or disclosed in the f/s that, in the auditor's judgment, is of such importance that it is fundamental to users' understanding of the financial statements would be used to emphasize: -changes in accounting principles (paragraph required) -**substantial doubt about going concern status (paragraph required) -GAAP not consistently applied (paragraph required) -uncertainties -significant related party transactions -important events (merger, major catastrophe) **The above circumstances for this paragraph are included after the opinion paragraph if deemed necessary -group audits

Positive Confirmation

A request that the confirming party respond directly to the auditor providing the requested information or indicating whether the confirming party AGREES OR DISAGREES with the information in the request

Negative Confirmation

A request that the confirming party respond directly to the auditors indicating where the confirming party DISAGREES with the information in the request **can only be used when: -risk of material misstatement is LOW -the auditor has no reason to believe that people receiving the confirmation won't respond -accounts receivable is made up of many small balances

Bank Confirmation

A standard confirmation sent to all banks with which the client had business during the year to obtain information about the year-end cash balance and additional information about loans outstanding. Designed to provide corroborating evidence about the client's account balances and outstanding loans Info on: - Loans - Contingent liabilities - Discounted notes - Pledged collateral - Guarantee, security agreements Completeness, existence, valuation, allocation **return to accountants, signed by the audit client, mailed by auditors**

Proof of Cash

An audit procedure that reconciles the bank's record of cash activity with the audit client's accounting records for a test period; working paper used for this is a four-column bank reconciliation this is used when controls over cash are considered to be weak

Litigation (Loss Contingency)

Perhaps the most common loss contingency auditors should: -inquire about these matters w/ management, others in the org, and in-house counsel -obtain form mgt a description and eval of the litigation, claims, and assessments including ID of those matters referred to legal counsel -review 1) minutes of meetings of those charged with governance 2) documents in mgt's possession regarding litigation, claims, and assessments 3) correspondence with legal counsel

Lapping

The concealment of a cash shortage by delaying the recording of cash receipts **i.e. someone initially stole a cash receipt, then misposted a subsequent A/R receipt to cover it up -->A comparison of the daily entries in the cash receipts journal w/ bank deposits may help uncover these; also review remittance advices

Cutoff Bank Statement

a bank statement covering a specified number of business days (usually 7 to 10) after the client's b/s date. This statement is used to determine that checks issued on or before the b/s date and paid during the ____ period were listed as outstanding on the YE bank reconciliation (test items on the reconciliation) also used to determine the reconciling items shown on the YE bank reconciliation have cleared the bank within a reasonable amount of time **mailed directly to auditors

Qualified (modified) Opinion

a modification of the auditor's standard report, employing a clause such as "except for" to limit the auditor's opinion on the f/s; this type of opinion indicates that, except for the effect of some limitation on the scope of the audit or some departure from GAAP, the f/s are fairly presented -requires a basis for modification (explanatory) paragraph that precedes the opinion paragraph *material departure from GAAP that doesn't overshadow the overall fairness of the statements; NOT PERVASIVE OR *scope limitation (unable to obtain sufficient audit info in a particular area)

Other Matter Paragraph

a paragraph included in the auditor's report that is required by GAAS or is included at the auditor's discretion and that refers to a matter other than those presented or disclosed in the financial statements that in the auditor's judgment is relevant to users' understanding of the audit, the auditor's responsibilities, or the auditor's report i.e.: to report on comparative statements when there are predecessor auditors OR to alert readers about the intended use of an audit report when it is not for general use -this paragraph follows the opinion and any emphasis of a matter paragraph

Scope Limitation

a restriction that prevents the auditors from being able to apply all of the audit procedures that they consider necessary in the circumstances; these may be client imposed, or may be imposed by other circumstances

Representation Letter

a single letter or separate letters prepared by officers of the client company a the auditor's request, setting forth certain representations about the company's financial position or operations -management asserts that they are primarily responsible for the fairness of the f/s; should be dated on the date of the audit report

Pervasive

a term used in the context of misstatements to describe the effects on the financial statements of misstatements or the possible effects on the financial statements of misstatements if any that are undetected due to an inability to obtain sufficient appropriate audit evidence these type of effects on the f/s are those that (in the auditor's opinion) -are not confined to specific elements, accounts, or items of the f/s -if confined, represent or could represent a substantial portion of the f/s -in relation to disclosures, are fundamental to users' understanding of f/s

Summary of Passed Adjustments

a working paper compiled by the auditors composed of immaterial misstatements that are discovered by the auditors and not corrected by the audit client *all the immaterial misstatements could amount to a material misstatement overall (when totaled)

Standard Report

an audit report with (1) an unmodified opinion and (2) no additional matters emphasized beyond the information required in all audit reports **while frequently used in practice the AICPA no longer officially includes this in its standards

Subsequent Events

an event occurring between the date of the financial statements and the date of the auditor's report type 1: additional evidence related to conditions that existed at the date of the f/s; requires that f/s amounts be adjusted to reflect the changes in estimates resulting from additional evidence type 2: involves conditions that arose after the f/s date; do not require adjustment to the dollar amounts show in f/s, but they should be disclosed in the f/s notes if the statements would otherwise be misleading

Adverse Opinion

an opinion that the financial statements DO NOT fairly present financial position, results of operations, and cash flows in conformity with GAAP; this situation occurs when the auditors believe that departures from GAAP are both material and persuasive misstatement is material AND pervasive **very rare to have this type of opinion