Audit Chpts 9-11, 16

How much audit time for cash?

- a lot of time despite it being a small amount on the BS because it can substantiate other items in BS like liabilities, revenues, and expenses since they all arise form cash transactions -most liquid and greatest temptation for theft or embezzlement or misappropriation -high inherent risk and higher detection risk

Dual-dating vs changing the date of report:

-"dual-dating" extends auditor's responsibility to the later date only for the specified item -using a later date extends the auditors' responsibility with respect to all areas of FS

When no significant exceptions or identified in supplementary information:

-AICPA = inclusion of "other matter paragraph" in the FS audit report indicating procedures performed (provides no assurance) -PCAOB = no paragraph required (optional)

Reviewing the Engagement

-AICPA and PCAOB require the work of each assistant be reviewed to determine it was adequately performed and documented, and to evaluate the results and conclusions to be presented in the auditor's report (review of workpapers) -seniors review staff's work throughout and communicate with partners and managers -partners and managers review workpapers near end of the fieldwork

How do auditors obtain evidence about many income statement accounts?

-Concurrently with related balance sheet accounts -EX: depreciation expense --> PPE (existence and cost); sales and COGS --> inventories (cutoff)

Additional Communications at end of audit:

-To audit committee: a)fraud and illegal acts b)significant deficiencies -To the BOD and audit committee: a)auditor's and management's responsibilities b) overview of the planned scope and timing c) significant findings (audit difficulties, uncorrected misstatements, significant unusual transactions, disagreements with management. etc)

conservatism

-a powerful force influencing decisions on revenues and expenses -subjectively involved with many estimates

window dressing

-actions taken around BS date to make financial picture look better -when cash receipts are not deposited daily, cash received for a few days after the close of the year may be included in a deposit dated as of YE, thus overstating the cash balance at BS date -auditors should carefully review all substantial sales returns following BS date that may apply to receivables originating in the year under audit

standard confirmation form

-addresses only the client's deposit and loan balances -used to corroborate the existence of recorded information -may lead to the discovery of additional accounts or loans (limited evidence about the completeness of recorded amounts)

block selection

-all items in a selected time period, numerical sequence, or alphabetical sequence -cannot generally be relied on to efficiently produce a representative sample

Audit of Cash: Use understanding...

-business risks = possible theft of these liquid assets; most misstatements of assets involve overstatement -Overstated cash: shortage could be concealed by inserting a fictitious check in cash on hand or by omission of an outstanding check at YE -recorded YE is correct, but should be higher (problem is fraud and its effects on other accounts) = interception of cash receipts before any record is made, payment for materials not received, duplicate payments, etc -completeness (management may want to understate cash to minimize income taxes -management maintains bank account not in books -manner client collects cash could present high risks (charity receiving large cash transactions)

Required supplementary Information

-certain organizations are required to present supplementary info as unaudited supplementary schedules accompanying the FS (not considered part of general purpose FS)

positive confirmation

-client makes request asking for a reply -most ask customer to confirm the accuracy of the dollar amount shown on the request

AR Substantive Procedures: Review of YE Cutoff of Sales Transactions

-common methods to falsify accounting records is to inflate the sales for the year by holding open the sales journal beyond the balance sheet date (EX: shipments made in the first part of Jan may be covered by sales invoices bearing a Dec date and included in Dec sales) -compare sales recorded several days before and after BS date with the sales invoices and shipping documents

How do you distinguish between the 2 types of subsequent events?

-consider when the underlying conditions came into existence -EX: customer files bankruptcy and receivable is now uncollectible a) if bankruptcy stems from steady deterioration, it is type 1 b) if bankruptcy stems from a casualty like a fire occurring after the BS date, it is type 2

Reviewing and confirming AR written-off as uncollectible:

-debits to allowance traced to the authorizing documents -confirmation requests may be sent to debtors to determine that the account was genuine when it was first in the accounts -credit entries should be compared with the charges of uncollectible accounts and notes expense

Why are revenues and receivables a significant risk to auditors?

-determination of the amount of revenue to be recognized in a period is integrally related to sales and AR, adjustments to sales and AR, service revenue, deferred revenues, and cash -major determinant of the amount of net income that the company reports for a particular period

What types of data is analyzed during audit procedures for subsequent events?

-determine proper cutoffs of cash receipts and disbursements, sales and purchases -examine data to aid in evaluating assets and liabilities as of the BS date

Stratification

-dividing a population into relatively homogeneous subgroups called strata -each strata is sampled separately -results may be evaluated separately or combined to provide an estimate of the characteristics of the total population -require a smaller number of sample items to evaluate the several strata separately than whole population without stratification -allows auditors to relate sample selection to materiality or other characteristics and apply different audit procedures to each strata -almost always used for audit sampling for substantive testing

Evaluating the risk of material misstatement

-evaluate whether accumulated results of their procedures affect the initial assessment of RoMM made in the beginning

AR Substantive Procedures: Confirm Receivables w/ Debtors

-evidence obtained externally as a direct written response confirmation request sent to a 3rd party -direct communication with debtor is most essential and conclusive step in verifying accounts receivable -establishes existence and valuation (and assurance against lapping) -if management refuses, auditors should perform alternate procedures and inquire/evaluate management's reasons (examination of subsequent cash receipts)

positive vs negative confirmations

-expense of negative confirmations is less than positive because there's no need to follow up to nonreplies -positive confirmations provide more assurance because nonreply causes alert for further investigation **blank forms control risk of debtor just signing without actually verifying

Other information in documents containing audited FS

-financial and nonfinancial -does not include required supplementary info -EX: a) a report by management on year's operating results b) financial summaries c) employment data d) planned capital expednitures e) financial ratios f) names of officers and directors -AICPA and PCAOB require auditors read this info for inconsistencies with the audited FS -if no inconsistencies, no need to reference info in auditor's report; if inconsistencies, request client revises incorrect info

Audit documentation for cash:

-flowchart or written description of controls -IC questionnaire -summary of tests of controls and assessments of risk -documentation of risk assessments, audit plan, a lead schedule, cash count sheets, bank confirmations, bank recs, etc

Pro Forma statements as a means of disclosure:

-for when subsequent event is so material -may be presented in columns next to the audited FS -only used when subsequent events has a significant effect on the asset structure or capital structure of the business (i.e. a business combination)

Audit of Cash: Understanding of IC

-from questions of owners and employees and observations -after flowcharts auditors do walkthrough = trace a transaction through each step of the system to determine if transactions are being processed like it says in the flowchart

Monitoring cash transactions

-important for management to monitor cash receipts and disbursements -in a manual system, management or internal auditors review cash journal and ledgers for unusual transactions or entries -in an IT system, D&A may be used to continuously monitor cash transactions for those that may be erroneous or fraudulent

Audit of AR: Use understanding...

-inherent risks = a decline in sales due to economic declines, product obsolescence, increased competition, or shifts in product or service demand; inability to collect receivable; improper rev rec (most common technique for fraudulent financial reporting); restrictions on sales by laws and regulations -responses to the risks = overall effect on how audit is conducted; design of audit procedures; performing further procedures to address risk of mm

Subsequent events less related to accounting matters:

-less likely to be disclosed (i.e. employee strikes, introduction of a new product line, or death of an executive)

Review the Financial Statement Disclosures

-loss contingencies -not effective to rely on auditor's memory for adequacy of disclosures nor to have them research every time they review a set of FS (use disclosure checklist to complete as part of their review of the completed FS)

Miscellaneous revenue

-mixture of minor items, nonrecurring, received at irregular intervals (if you receive a cash payment and are unsure of the source)

Supplementary information in relation to FS as a whole:

-nonrequired -perform procedures to provide assurance it is stated fairly in regards to FS as a whole -must be derived from and relate directly to underlying accounting and other records (consolidating information, historical summaries of accounts, statistical data)

Random sampling (selection)

-not equal to statistical sampling -the procedure of selecting the items to include in a sample -can be used in conjunction with statistical or nonstatistical sampling -principle is that every sampling unit has an equal chance of being selected (results in a statistically unbiased sample, but may not be representative)

AR Substantive Procedures: Evaluate Propriety of Client's Accounting Methods for AR and revenue

-obtain reasonable assurance management is following the appropriate accounting framework -should have proper management review controls -thorough understanding of related contracts (evaluate significant assumptions regarding revenue recognition) -evaluate determination of transaction price and performance obligations, terms, and customary business practices

What FS assertions are related to the tests of revenue and expenses?

-occurrence of transactions -completeness of transactions -accuracy of transactions -cutoff of transactions -presentation and disclosure or accounts (classification and presentation of EPS data)

Audit of AR: Assess risks of material misstatement and design further audit procedures

-potential misstatements = recognizing revenue not yet earned, early or late recognition (cutoff), recording revenue when significant uncertainties exist, recording revenue when significant performance obligations still must be performed, overestimation of amount of revenue

In concluding the work on revenues auditors should:

-propose adjusting entries to classify correctly any material items -perform analytical procedures and investigate unusual fluctuations

voucher register

-replaces purchases journal -computer purchasing system matches information on purchase orders with inputs

Materiality-effects of PY uncorrected misstatements

-rollover approach and iron curtain approach -SEC requires both be considered; if either results in a material misstatement and adjustment must be made -if PY misstatement is material to current year, the PY FS should be adjusted (even if immaterial PY) -if PY misstatement is immaterial to current year, it may be included as an expense on this year's income statement instead of restating PY FS

Haphazard selection

-select on an arbitrary basis -should not consist of items selected in a careless manner, it should still be representative

Disclosure of subsequent events

-should include an estimate of the financial impact or a statement saying an estimate could not be made -auditors may choose to add an "emphasis-of-matter" paragraph to the report referring to the subsequent event

When supplementary information is omitted or improperly stated:

-situation in described in an "other matter paragraph" ("explanatory paragraph" per PCAOB) -opinion paragraph is not modified because the supplementary information is not considered a part of the audited information

How do auditors treat subsequent events that come to their attention after BS date but before the report release date?

-still responsible for evaluating -if event requires adjustment but no disclosure note, the report continues to be dated as of the date the auditors had sufficient audit evidence -if note disclosure is necessary, auditors can "dual-date" the report or change date to after they return to the client for further review

Audit Sampling

-the process of selecting and evaluating a sample item from a population of audit relevance -must be representative of some characteristics of the population -can be statistical or non statistical

sampling risk

-the risk of the sample not being representative -when entire population is sampled, sampling risk = 0 -strike a balance between sampling risk and audit efficiency (of auditing less terms)

Type 2 subsequent event

-those involving facts coming into existence after the BS date -do not require adjustment to BS amounts, but should be disclosed in FS notes if the statements would otherwise be misleading -EX: in case of a fire after BS date, PPE should not be reduced because the assets were in tact at the BS date. However, people analyzing the FS would be misled if not advised that most of the PPE are no longer in a usable condition -Other EXs: sale of bond or capital stock, a business combination with another business, settlement of litigation when the event happened after the BS date, loss of plant or inventories due to fire, loss of receivables due to customer death, changes in fair value of assets or liabilities from foreign exchange rate

Type 1 subsequent event

-those providing additional evidence about facts existing on or before the BS date -requires FS amounts be adjusted to reflect the changes in estimates resulting from the additional evidence -EX: evidence becoming available after the BS date through the date of issuance of the auditor's report should be used in making judgements about the valuations of receivables -Other EXs: new terms on an existing contract made in Jan needs revision of revenue recognition for Income Statement, litigation that was pending at the BS date is settled in Feb requires the liability on the BS be accrued

Sources and Nature of AR

-trade receivable that arise from credit sales of goods or services to customers (trade notes and AR should be separate on the BS) -loans to officers and subsidiaries, claims against other firms, claims for tax refunds, and advances to suppliers (especially concerned with the presentation and disclosure of loans to officers, directors, and affiliated companies)

Materiality-considering quantitative factors

-unmodified opinion = low level of risk of material misstatement on FS -reassess materiality to determine if its still appropriate -consider uncorrected misstatements together and separately (closer auditors' estimated uncorrected misstatements are to materiality. the higher the risk of material misstatement) -offsetting misstatements (overestimation of revenue and expenses) are usually inappropriate in professional standards (exception may be made in limited circumstances when offset is within the same account balance or class of transactions [may need to reassess RoMM)

Statistical sampling

-use appropriate statistical techniques to evaluate sample results -does not eliminate professional judgement from sampling process -allows auditors to measure and control sample risk -(1) specify sampling risk they want in results, (2) compute sample size that controls the risk to that level -based on the laws of probability

Audit of Cash: Determine risk of material misstatement and design further procedures

-use evidence gathered to determine planned assessed levels of the risks of material misstatement for assertions -if additional evidence of effectiveness of the control is needed to support the assessed levels of control, auditors design tests of controls (determine which will reduce substantive procedures to justify time spent)

Nonstatistical sampling

-use judgement to measure sampling risk -no means of actually quantifying sampling risk -may take larger, more costly sample than necessary -may unknowingly accept a higher-than-acceptable degree of sampling risk due to small samples

Audit of AR: Understanding of IC

-written narrative/flowchart/questionnaire -walkthroughs -confirm understanding of revenue cycle -inspect documents and review revenue budgets

Cash Disbursements IC

1) Checking Account Disbursements -principal advantage is obtaining evidence of receipt from payee (reduces cash on hand and centralized disbursement authority) -must be prenumbered in series -voided checks kept and defaced -printed dollar amounts review supporting documents before signing 2) Employee Reimbursements -employee submits expense report -approved by supervisor and sent to accounting -must document explanations for expenditures when given credit cards 3) Petty Cash Funds -custodian reviews support from employees seeking reimbursements -often immaterial, so auditors focus on transactions (test replenishment transactions)

Guidelines for IC over cash:

1) not 1 employee handling transaction from beg-end 2) separate handling (custody) from record keeping 3) centralize receiving of cash 4) record receipt on a timely basis 5) encourage customers to obtain receipts and observe register totals 6) deposit receipts daily 7) all disbursements by check or electronic (except petty cash) 8) monthly bank recs, prepared by employee not responsible for cash payments or custody, reviewed by official 9) use software to monitor receipt and disbursement to identify unusual transactions and compare to actual budget

Revenue verified through which BS accounts?

1. AR --> sales 2. Notes R --> interest revenue 3. Securities and other investments --> interest, dividends, gains on sales, share on invested income 4.PPE --> rent, gains on sale 5. Intangible assets --> royalties

Expenses verified through which BS accounts?

1. AR and Notes R --> uncollectible accounts and notes expense 2. Inventories --> purchases, COGS, and payroll 3. PPE --> depreciation, repairs and maintenance, depletion 4. Intangible assets --> amortization 5. Accrued liabilities --> commissions, fees, bonuses, product warranty expenses, and others 6. Interest-bearing debt --> interest expense

Conservatism in valuation of assets vs liabilities:

1. Assets = when two or more reasonable alternative values are indicated, the accountant will choose the lower amount 2. Liabilities = the higher amount is chosen

Post audit responsibilities:

1. Auditor's discovery of facts existing at the date of their report: -immediate investigation -if the facts are significant, advise client to make appropriate disclosure to all relying on FS and audit report -in US for public companies, disclosure that FS should no longer be relied on = Form 8-k with the SEC 2. Subsequent discovery of omitted audit procedures: -may have issued report without having gathered sufficient evidence -professional standards require auditors assess importance of the omitted procedures to their previously issued opinion -if it impairs ability to support previously issued opinion, they perform the omitted procedures or alternate procedures and contact their legal team

Cash Receipts IC

1. Cash and Credit Card Sales -strongest when 2 or more employees participate in transaction -in retail, 1 employee handles transaction but cash register discourages dishonesty (display total, printed receipt, accumulation of total sales) -credit cards require use of terminal to process payment (online authorization) 2. Electronic Point-of-Scale Systems -electronic cash registers, read universal product code -employee scans code and transaction/sale is recorded -risk of employee recording sales at erroneous prices is reduced -can be programmed for other controls 3. Collections from credit customers -for manufacturing and wholesale companies, cash receipts include checks received through mail (process for this with segregation of duties) 4. Direct Receipt of Funds (Financial Institutions) -sales proceeds are often received by client's bank -lockbox for businesses receiving large amounts of cash through mail 5. Electronic Funds Transfer -require extensive set of computer network control relating to system access and data entry 6. Recording Cash Receipts -employee responsible for customer's accounts ledger enters the details in batches to the computer -cash receipts program creates file for cash receipt transactions (update general ledger and master file of AR) -control totals and exception reports -manual follow up procedures

IC over AR and Revenue

1. Control environment - effective BOD that provides effective oversight of management's judgements about revenue recognition principles and estimates (is management aggressive or conservative in selecting methods of rev rec) 2. Risk assessment - management should have formal process of monitoring external factors like economic conditions, competition, etc. (also evaluate internal factors like changes in accounting principles) 3. Accounting Systems and Control Activities - (a) prep of the sales order, (b) credit approval, (c) issuance of merch from stock, (d) shipment, (e) billing, (f) invoice verification, (g) maintenance of control accounts, (h) maintenance of customer's ledgers, (i) approval of returns and allowances, (j) authorization 4. Monitoring - reviewing various types of performance reports; carefully review aging of accounts receivable and solicit feedback from customers about the accuracy of billing; internal auditors may takeover mailing of monthly statements or send confirmations and investigate discrepancies

Categories of misstatements

1. Factual (known): auditor can calculate the accurate amount; make appropriate adjusting entry to remedy 2. Judgmental: differences in judgement between management and auditors concerning estimates or applications of accounting policies; amount of misstatement is difference between management and auditor's amount considered to be reasonable (the one closest to management's) 3. Projected: auditor's estimate of misstatement arising from using audit sampling; misstatement amount is difference between book value and estimated audit value from sampling; amount should be decreased by amount of factual misstatements, if factual misstatements are not corrected they should be included with all other factual misstatements identified by auditors

What if risk of material misstatement is too high in conclusion?

1. Factual misstatements: request management records the needed adjustments 2. Judgmental misstatements: management should be asked to review the assumptions and methods used in developing estimates, and auditors perform further procedures to reevaluate reasonableness of estimate 3. Projected misstatements: request management examine additional items in account to identify and correct other misstatements and auditors may expand the scope of audit procedures and reevaluate the reasonableness of projected misstatements

Required procedures for supplementary information:

1. Inquire of management - about methods of preparing information (if it was prepared following guidelines, methods of measurement, or significant assumptions 2. Compare information - for consistency with management's responses to the inquiries, the basic FS, and other knowledge obtained during the audit 3. Obtain written representations - from management acknowledging its responsibility for the information

Audit procedures for subsequent events

1. Obtain understanding of management's procedures to ensure that subsequent events are identified 2. Inquire of management about whether subsequent events have occurred 3. Read meeting minutes that have been held after BS date 4. Read the company's latest subsequent interim FS, if any

Substantive Procedures for Selling, General, and Admin:

1. Perform analytical procedures related to the accounts a) develop expectation of account balance (consider factors such as budgeted amounts, industry averages, PY amounts, relationships among financial data, and relevant nonfinancial data) **effective budgets provide auditors with good expected amounts and increases likelihood of management defecting errors b) determine acceptable difference (use materiality estimates and consider extent of assurance desired) c) compare account balance with expected balance d) investigate significant deviations (starting with inquiry of management, then substantiate management's explanations) 2. Review journals and ledgers for unusual items that may be indicative of misstatements (unusually large entries, entries from unusual sources, and entries with unusual timing) 3. Obtain or prepare analyses of selected expense accounts (client should be requested to furnish analyses of selected accounts together with related vouchers and other supporting documents [i.e. advertising, R&D, legal expenses, maintenance & repairs, rents and royalties) 4. Obtain or prepare analyses if critical expenses in income tax returns (tax returns generally require schedules for officers' salaries, director's fees, taxes, travel and entertainment, contributions,. and casualty losses; officer's expense account allowances are presented in analysis of their salaries)

Techniques for random sampling

1. Random number generators (assign a number to each sampling unit and use software like excel to generate a random number for you to choose) 2. Random number tables (similar to random number generators except assign sampling unit to numbers in the table and pick a starting point) 3. Systematic selection (select every nth item in the population following one or multiple starting points; does not work if population positions are assigned in other than random order)

Objectives in the audit of cash:

1. Use understanding of client to consider inherent risks (fraud risk) 2. Obtain understanding IC 3. Assess risk of material misstatements of cash and design test of controls and substantive procedures

Objectives for the audit of revenue and expenses:

1. Use understanding to assess inherent risks (fraud risks) 2. consider internal control 3. assess risks of material misstatement and design further audit procedures

Internal control over cash provides assurance that:

1. all cash that should have been received was received, recorded accurately, and deposited promptly 2. cash disbursements were made for authorized purposed only have been properly recorded 3. cash balances are adequate, but not excessive, by forecasting expected cash receipts and disbursements related to normal operations (also make need for a loan known on a timely basis)

Types of statistical sampling

1. attribute sampling (to estimate the rate of occurrence in the population; normally used in test of controls)\ 2. Discovery Sampling (to locate at least one deviation in the process; used when auditors expect a very low rate of occurrence) 3. Classical Variable Sampling (provides an estimate of a numerical quantity such as balance of AR; commonly used in substantive tests) 4. Probability-Proportional-to-Size (PPS)

What things may auditors find improperly included in miscellaneous revenue?

1. collections on previously written off AR/NR (should be recorded as an increase in the allowance for uncollectible notes accounts) 2. write-offs of old outstanding checks or unclaimed wages (should be credited to a liability account) 3. proceeds from sales of scrap (sales proceeds should be applied to reduce COGS) 4. rebates or refunds on insurance premiums (should be offset against the related expense or unexpired insurance) 5. proceeds from sales of plant assets (should be accounted for in the determination of the gain or loss on the asset sold)

What do auditors use to highlight errors, omissions, and inconsistencies not disclosed in the audit of BS accounts?

1. cross-referencing 2. analytical procedures 3. analysis of specific transactions

Statistical sampling may assist auditors with:

1. designing efficient samples 2. measuring the sufficiency of the evidence obtained 3. objectively evaluate the results

Steps for significant RoMM in AR and revenue:

1. evaluate the design of the related controls and determine that they are implemented 2. may not rely solely on analytical procedures to address the risk 3. may not rely on evidence obtained in prior periods regarding the operating effectiveness of the related controls

Audit of AR: Perform further audit procedures - Tests of Controls

1. examine significant aspects of a sample of transactions (compare customer purchase orders, client sales order, and sales invoice) 2. compare details of a sample of shipping documents to related sales invoices (ensure all shipments have been billed and account for all serial documents by serial number) 3. review the use and authorization of credit memoranda (all allowances to customers should have serial number memoranda, should require goods be inspected before credit is granted) 4. reconcile selected cash register tapes and sales tickers with sales journals (for clients that have substantial amount of sales as cash) 5. test IT application controls (test directly instead of testing a sample of sales transactions) 6. examine evidence of review and approval of revenue estimates **revise RoMM based on results of tests of controls

What risks are involved with confirming receivables?

1. information delivered to inappropriate address and signed by non-authentic source 2. improper intervention into the delivery of a properly addressed confirmation request 3. information was delivered properly, but an inappropriate individual may reply

Procedures for supplementary information in relation to FS as a whole:

1. inquire of management about the purpose of the information and criteria used to prepare it 2. determine the propriety of the form and content of the information (including compliance with regulations) 3. obtain understanding of how the information was prepared 4. compare and reconcile information to underlying accounting and other records 5. inquire of management concerning significant assumption 6. evaluate the appropriateness and completeness of the information 7. obtain written responses **other-matter paragraph is added outlining procedures and whether the information is fairly stated

What should auditors be aware of when reviewing YE cutoff of sales transactions?

1. large increases in YE sales to a single customer or few 2. increases in revenue and AR and gross profit that don't match client's experience or industry average 3. inappropriate changes in accounting principles that result in an increase in recorded revenue 4. substantial returns following the BS date (could indicate channel stuffing) 5. substantial revisions in the amount to be received under sales contracts (could indicate inappropriate accounting methods or misestimates of the amount of revenue to be realized

Audit of AR: Further audit procedures - Substantive Procedures

1. obtain an aged trial balance of trade AR and analysis of other AR and reconcile to ledgers (accounts both current and past) 2. obtain analysis of notes receivables and related interest to the general ledger 3. inspect notes on hand and confirm those with holders 4. confirm receivables with debtors 5. perform analytical procedures for AR, notes receivable, and revenue (search for unusual large and suspicious sources, revenue cutoff errors, duplicate billings, unauthorized discounts) 6. review significant YE sales contracts of unusual terms (unusual pricing, billing, delivery, returns, exchanges, and acceptance clauses) 7. review the YE cutoff of sales and transactions 8. test the valuation of notes receivable, computations of interest income, interest receivable, and amortization of discount or premium 9. evaluate propriety of clients accounting methods for receivables and revenue 10. evaluate accounting estimates related for revenue recognition (sales returns, revenue for complex agreements, allowance for uncollectible accounts, review and test method of estimate or subsequent transactions that provide evidence to the accuracy of the estimates) 11. determine the adequacy of client's allowance for uncollectible accounts 12. ascertain whether any receivables have been pledged (may be disclosed through the medium of financial institution confirmation requests that describe the collateral securing bank loans, or identified through coding in the AR records) 13. investigate any transactions with or receivables from related parties (review filings with SEC, conflict of interest statements, adequate disclosure) 14. evaluate financial statement presentation and disclosure of receivables and revenue (presentation and notes follow GAAP, related party receivables shown separately, unusual terms of notes, and amounts of allowances for uncollectible receivables should be shown as deductions from related receivables)

Audit of Cash: Further Audit Procedures - Substantive Tests

1. obtain analysis of cash balances and reconcile them to the general ledger 2. confirm cash balances with financial institutions (confirm amounts on deposit and make bank recs) 3. obtain or prepare reconciliations of bank accounts as of the BS date and consider the need to reconcile bank accounts for additional months (begins with balance per bank and ends with unadjusted balance per the accounting records) 4. obtain a cutoff bank statement containing transactions of at least 7 business days after BS date (tests accuracy of YE reconciliation; examine checks outstanding and deposits in transit) 5. identify and investigate unusual cash receipts and disbursements (from unusual sources or suspicious persons, duplicate payments/receipts, related parties) 6. count and list cash on hand (surprise count before or after BS date, custodian must be present) 7. verify the client's cutoff of cash receipts and cash disbursements (determine deposits in transit shown on the YE bank recs appear as credits on bank statement on first business day of new year) 8. analyze bank transfers for the last week of the audit year and the first week of the following year (to disclose overstatement of cash balances resulting from kiting) 9. investigate payments to related parties (large or unusual checks to determine proper authorization and adequate disclosure) 10. evaluate proper financial statement presentation and disclosure of cash (BS figure should include only those amounts that are available for use in current operations; agreements to maintain compensating balances should be disclosed)

What problems may auditors encounter when evaluating the propriety of client's accounting methods for AR and revenue?

1. revenue estimates don't consider sales returns rights 2. side agreements that alter the terms of the sale 3. cash receipts from franchise fees may be inappropriately recognized when services have not been rendered to the franchise 4. bill and hold transactions recorded without meeting revenue recognition requirements 5. notes don't bear reasonable interest rates 6. overstatement of revenue on construction contract 7. overloading revenue recognition on performance obligations initially completed

Sampling risk for test of controls

1. risk of assessing control risk too high (efficiency) - less test of controls, resulting in more substantive tests that take much more time (if sample results are inadequate but actual population is adequate) 2. risk of assessing control risk too low (effectiveness) - less substantive tests and more tests of controls, resulting in more chances of missing something and/or being misled (sample results are adequate but actual population is inadequate)

When should negative confirmations be used?

1. the assessed level of the risk of material misstatement is low and sufficient appropriate audit evidence has been obtained on operating effectiveness of controls 2. a large number of small balances are involved 3. low exception rate is expected 4. auditors are not aware of circumstances that would cause recipients to disregard them **larger sample size is used for negative confirmation requests

Objectives in the audit of receivables:

1. use understanding of client....assess risks 2. obtain understanding of IC 3. assess risks of material misstatement for all the assertions

AR Substantive Procedures: Determine the Adequacy of Client's Allowance for Uncollectible Accounts

Auditors develop their own estimate: 1. compare current year to PY 2. investigate credit ratings for delinquent ad unusually large accounts (when one or few customers represent major portion of total) 3. review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts' 4. summarize findings of doubtful collectability 5. review current status of doubtful accounts, determine collection action taken, and opinion of creditor as to ultimate collectability 6. compute relationships like day's sales in AR and valuation allowance to AR and net credit sales, compare to PY and industry averages1

Two types of subsequent events

Type 1: those providing additional evidence about facts existing on or before the BS date Type 2: those involving factors coming into existence after the BS date

What FS assertions are related to cash?

a) existence of recorded cash and occurrence of cash transactions b) accuracy of transactions c) completeness of recorded cash d) cutoff of cash transactions e) rights to recorded cash f) presentation and disclosure

Audit of Cash: Further audit procedures - Tests of Controls

a) test the accounting records and recs by reperformance -determine if accounting procedures are operating effectively -test accuracy of journals and ledgers -test procedures for reconciling bank accounts b) compare details of a sample of cash receipts listings to the cash receipts journal, AR postings, and authenticating deposit slips c) compare details of a sample of recorded disbursements in the cash disbursements journal to accounts payable postings, purchase orders , receiving reports, invoices, and paid checks -tracing selected items through disbursements journal to original source document determine if agreements exists among supporting documents

voucher

an authorization sheet that provides space for the initials of the employees performing various authorization functions (extending and footing the vendor's invoice, determining agreement of the invoice, purchasing order, and receiving report, and recording the transaction in the accounts)

subsequent events

an event occurring after the date of the BS but prior to the date of the auditor's report

Check 21 Act

checks are allowed to be processed electronically

negative confirmations

client makes request for customer to advise the auditors only if the balance shown is incorrect

iron curtain approach

consider BS effect of correcting the total misstatement, regardless of where it originated

rollover approach

consider only current year misstatement amount

How do you reduce nonsampling risk?

effective planning and supervision of audit engagements; appropriate design of quality control

Tolerable Misstatement

estimate of the approximate monetary misstatement that may exist in an account, when combined with misstatements in all other accounts, will not cause FS to be misstated

Evaluating audit findings:

evaluate importance of all uncorrected misstatements identified and in the aggregate -determine whether they are material -look at both quantitative and qualitative factors -immaterial ones are accumulated in the workpapers and auditors make judgement on if overall effect + effect of all undetected misstatements is material

Valuation assertion for cash?

included rarely, but could be included for foreign transaction currency or reconciling underlying records to the general ledger

How do you reduce sampling risk?

increase the size of the sample

Cash & Financial Investments

liquid in nature, and transfers between the two accounts occur frequently (liquid nature of cash increases the risk of fraud, which may be harder to detect than an error)

kiting

manipulations that utilize temporarily overstated bank balances to conceal a cash shortage or meet short term cash needs (decreased by bank transfer schedule) -EX: when a company transfers funds from one bank account to another and it takes days for the check to clear from the bank it was drawn from (float period) it appears in the balance of both accounts

Materiality-considering qualitative factors

misstatement may be material if it: 1. arise from an item capable of precise measurement (i.e amount of a sale) rather than from an estimate 2. mask a change in earnings or other trends 3. hide a failure to meet analysts' consensus expectations for the company 4. change a loss into income, or vice versa 5. concern a particularly important segment or other portion of the registrant's business 6. affect compliance with regulatory requirements, loan covenants, or other contractual requirements 7. increase management's compansation 8. involve concealment of an unlawful transaction 9. are of an amount that management or auditors believe would affect the stock's price **SEC requires management and auditors apply reasonableness standard in consideration of fairness of financial presentation

Sampling with or without replacement:

most frequently auditors use sampling without replacement because it results in a slightly smaller required sample size and eliminates questions about the propriety of including items more than once in evaluating the sample results

Which type of sampling is mostly used by auditors and why?

nonstatistical because statistical sampling has additional costs of training the audit staff, designing sampling plans, and selecting items for examinations (nonstatistical sampling especially used for tests of relatively small populations)

Conservatism when applied to the income statement:

results in a low income figure

bill and hold transactions

sales are billed but goods are not shipped (this does not meet revenue recognition requirements)

compensating balance

specified minimum balance of cash in general account under terms of a bank loan agreement

lapping

the concealment of a cash shortage by delaying the recording of cash receipts (most easily carried on when the employee who receives collections from customers is the same one who posts them to customer accounts)

nonsampling risk

the risk of drawing erroneous conclusions from non sampling errors (i.e. failure to apply appropriate audit procedures or failure to recognize errors in documents and transactions analyzed)

What does is mean for a sample to be representative?

the sample will result in conclusions that are similar to those that would result from testing the entire population

Representation letters

to have client's principle officers acknowledge that they are primarily responsible for the fairness of the financial statements (should be dated as of the date of the auditor's report)

Communicating misstatements to management:

unresolved differences in opinion about misstatement adjustments result in modification of the auditor's report (opinion)