Audit Chapter 5

Completeness

*Keyword understatement* -All assets, liabilities, equity interests, and transactions that should have been recorded have been recorded.

Existence and Occurrence

*keyword overstatement* - Assets, liabilities, and equity interests exist and recorded transactions and events have occurred

Nonroutine Transactions

A transaction that occurs only periodically, such as counting and pricing inventory, calculating depreciation expense, or determining prepaid expenses.

List of Relevant Assertions

- Existence and Occurrence - Rights and Obligations - Completeness - Cutoff - Valuation, Allocation, and Accuracy - Presentation and Disclosure

Reasonableness Test

- Similar to regression analysis in that an explicit expectation is computed for the financial statement amount using financial or non financial data. - Different from regression analysis in that it is less formal and is not based on a statistical model

How long do you retain work papers?

-If it is a public company, 7 years -If it a non public company, 5 years

Types of Audit Procedures

-Inspection of records and documents -Inquiry of knowledgeable persons within or outside the entity -External confirmation -Inspection of tangible assets -Observation of processes or procedures being performed by others -Recalculation of mathematical accuracy -Reperformance of procedures -Analytical Procedures

Audit Evidence is More Reliable When it is

-Obtained from knowledgeable independent sources outside the client company rather than nonindependent sources -Generated internally though a system of effective controls rather than ineffective controls -Obtained directly by the auditors rather than indirectly or by inference -Documentary in form rather than in the form of an oral representation -Provided by original documents rather than photocopies or fasimiles

Procedures formed so Auditors know the client's financial statements follow GAAP

-Risk Assessment Procedures -Tests of Controls -Substantive Procedures

Estimation Transactions

A transaction involving management's judgments or assumptions, such as determining the allowance for doubtful accounts, establishing warranty reserves, and assessing assets for impairment.

Cutoff

-Transactions and events have been recorded in the correct accounting period *bills and hold scheme- bill client and hold inventory until the period is over*

How auditors obtain an understanding of how manage develops estimates

1. Review and test management's process of developing the estimates, which often involves evaluating the reasonableness of the steps performed by management 2. Independently develop an estimate of the amount to compare to management's estimate 3. Review subsequent events or transactions bearing on the estimate, such as actual payments of an estimated amount made subsequent to year-end.

Tests of Details Divided Into Three Types

1. Tests of Account Balances 2. Tests of Classes of Transactions 3. Tests of Disclosures

Permanent File

A file of working papers containing relatively unchanging data, such as copies of articles of incorporation and bylaws; copies of minutes of directors', stockholders', and committee meetings; and analyses of such ledger accounts as land and retained earnings.

Relevant Assertion

A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated. -Made without regard to the effect of controls

Vertical Analysis or Common-Size Financial Statements

A form of analysis that presents financial statement amounts for a period as a percentage of some financial statement base.

Minutes

A formal record of the issues discussed and actions taken in meetings of stockholders or the board of directors

Representation Letter

A single letter or separate letters prepared by officers of the client company at the auditors' request setting forth certain representations about the company's financial position or operations.

Electronic Data Interchange

A system in which data are exchanged electronically between the computers of different companies. In an EDI system, source documents are replaced with electronic transactions created in a standard format.

Horizontal Analysis

A technique that involves comparing financial statement amounts and ratios for a particular company from year to year

Cross-Sectional Analysis

A technique that involves comparing the client's ratios for the current year with those of similar firms in the same industry. *comparing client's ratios to industry averages*

Routine Transactions

A transaction for a recurring financial activity recorded in the accounting records in the normal course of business, such as sales, purchases, cash receipts, cash disbursements, and payroll

Related Party Transactions

A transaction in which one party has the ability to influence significantly the management or operating policies of the other party, to the extent that one of the transacting parties might be prevented from pursuing fully its now separate interests.

Reclassification Journal Entry

A working paper entry drafted by the auditors to assure fair presentation of the client's financial statements, such as an entry to transfer accounts receivable credit balances to the current liabilities section of the client's balance sheet. -Not posted to the client's ledger accounts

Working Trial Balance

A working paper that lists the balances of accounts in the general ledger for the current and the previous year and also provides columns for the auditors' adjustments and reclassifications and for the final amounts that will appear in the financial statements. - *the "backbone" of the entire set of audit working papers*

Inherent Risk

The risk of material misstatement of a financial statement assertion, assuming there were not related controls. -In assessing this risk, it is useful to segregate transactions into three types-routine, non routine, and estimation

Presentation and Disclosure

Accounts are described and classified in accordance with generally accepted accounting principles, and financial statement disclosures are complete, appropriate, and clearly expressed.

Valuation, Allocation, and Accuracy

All transactions, assets, liabilities, and equity interests are included in the financial statements at proper amounts

Audit Evidence

Any information that corroborates or refutes the auditors' premise that the financial statements present fairly the client's financial position and operating results.

Substantive Procedures

Are designed to detect material misstatements of relevant assertions. These procedures include (a) analytical procedures and (b) tests of details of account balances, transactions, and disclosures

Risk Assessment Procedures

Are designed to obtain an understanding of the client and its environment, including its internal control, to assess the risks of material misstatement

Tests of Controls

Are designed to test the operating effectiveness of controls in preventing or detecting material misstatements

AR

Audit Risk

Certified Valuation Analyst (CVA)

Confirm complicated items beyond CPA's knowledge like leases

CR

Control Risk

Control Risk

The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control.

DR

Detection Risk

Corroborating Documents

Documents and memoranda included in the working papers that substitute representations contained in the client's financial statements. These working papers included audit confirmations, lawyers' letters, copies of contacts, copies of minutes of directors' and stockholders' meetings, and representation letters from the client's management.

Experienced Auditor

For purposes of audit documentation, an individual who has practical audit experience and a reasonable understanding of (1) audit processes; (2) Statements on Auditing Standards (SASs) and applicable legal and regulatory requirements; (3) the business environment in which the entity operates; and (4) auditing and financial reporting issues relevant to the entity's industry.

Confirmations

Generally effective at providing evidence about the assertion of existence of accounts, but they are less effective at addressing completeness and the appropriate valuation

IR

Inherent Risk

Adjusted Journal Entries

Journal entries designed to correct misstatements found in a client's records

Least Reliable Evidence

PBCs

Working Papers

Papers that document the evidence gathered by auditors to show the work they have done, the methods and procedures they have followed, and the conclusions they have developed in an audit of financial statements or other type of engagement.

Most Reliable Evidence

Prepared by external 3rd party

RPT

Related Party Transactions

Timing of Analytical Procedures

Required at the risk assessment stage and near the end of the audit.

AICPA AU 580 (PCAOB 333)

Requires auditors to obtain a representation letter on every engagement and provides suggestions as to its form and content

RMM

Risk of Material Misstatement

Negative Confirmation

Small paragraph sent to debtors in which they only respond if something is wrong.

Current Files

The auditors' report for a particular year is supported by the working papers contained in this file.

Scanning

The auditors' use of professional judgment to review accounting data to identify significant unusual items that will be tested. -A type of analytical procedure

Rights and Obligations

The company holds rights to assets, and liabilities are the obligations of the company

Documentation Completion Date

The date on which documentation should be completed. This is within 60 days of the delivery date.

Report Release Date

The date the auditor grants the client permission to use the auditor's report. This date is ordinarily close to the audit report date.

Second Partner Review

The purpose of this type of review is to provide assurance that all the CPA firm's in-house quality control policies have been complied with, as well as to provide a "second opinion" that the audit was performed in accordance with GAAS. -Sometimes called a quality review or cold review -Performed by a partner with no personal or professional ties to the audit client

Audit Risk

The risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.

Detection Risk

The risk that the auditors' procedures will lead them to conclude that a financial statement assertion is not materially misstated when in fact such misstatement does exist.

Audit File

The unit of storage for a specific audit engagement. The audit documentation for each year's audit of a company is included in this file.

Administrative Working Papers

Working papers specifically designed to help the auditors in the planning and administration of the engagement, such as audit programs, internal control questionnaires and flowcharts, time budgets, and engagement memoranda.

Positive Confirmation

sending out the actual amount the debtor owes the particular client and asking the debtor to verify the particular amount or to note exceptions (most successful way for auditors to get this info)