Audit Exam 3

Internal control questions regarding Debt and Equity Capital

- Are amounts of new debt authorized by appropriate management? - Is an independent trustee used for all bond issues? - Does a company official monitor compliance with debt provisions?

Audit of Intangibles

- Assets with definite useful lives are audited similar to property, plant and equipment - Assets with indefinite useful lives (e.g., goodwill) must be tested for impairment - Auditors generally rely on business valuation specialists to value goodwill for tests of impairment

Required Communication with Those Charged with Governance

- Auditor responsibility under generally accepted auditing standards (e.g., to form and express an opinion, and management's responsibilities) - An overview of the planned scope and timing of the audit - Significant findings from the audit

Sources of owner's equity

- Corporate accounts - Capital stock accounts - Preferred and common - Retained earnings - Prior period adjustments - Transactions generally few in number but material in amount

Presentation and Disclosure of PPE 3 things

- Disclose major classes of depreciable assets - Accumulated depreciation - Principles:

Analyze repairs and maintenance expense accounts to:

- Discover items that should have been capitalized - Use company policy to determine consistency in application - Analyze monthly amounts for significant variations from: - Month to month - Between corresponding months of two years

timing of examination for capital stock

- Few transactions but material in amount - Analysis most efficient after close of period - More time for first audit then continuing audit client

Potential Misstatements—Cash Disbursements

- Inaccurate recording of a purchase or disbursement - Duplicate recording and payment of purchases - Unrecorded disbursements

Primary concern of accounts payable

- Possibility of understatement or omission of liabilities - Exaggerates the financial strength of company - Conceals fraud as effectively as overstatement of assets - Accompanied by understatement of expenses and overstatement of net income

For Misc. Revenue an Auditor should do what?

- Propose adjusting journal entry to classify items correctly - Perform analytical procedures and investigate unusual fluctuations - Can detect material mounts of unrecorded revenue and - Significant misclassifications affecting revenue

Auditors' Approach for Depreciation

- Review and test management's process of developing the estimate - Review subsequent events or transactions bearing on the estimate - Independently develop an estimate of the amount to compare to management's estimate

Procedures to Identify Subsequent Events

- Review latest available financial statements and minutes of the board and selected committees - Inquiry about matters dealt with at meetings for which minutes are not available - Inquiry of management - Obtain lawyer's letter - Obtain representations from management

Audit Procedures Completed Near the End of Field Work

- Search for unrecorded liabilities - Review the minutes of meetings - Perform final analytical procedures - Perform procedures to identify loss contingencies - Perform the review for subsequent events - Obtain the representation letter

Sources of Accrued Liabilities

- Sometimes called accrued expenses - Examples: Salaries, interest, rent - Accumulate over time and management must make accounting estimate at year-end. - Note that if management does not make such an estimate, no entry will occur since the related transactions (e.g., interest) may have occurred months ago

Potential Sources of Unrecorded A/P

- Unmatched invoices and unbilled receiving reports - Vouchers payable entered in the voucher register subsequent to balance sheet date - Invoices received after balance sheet date - Consignments in which client acts as a consignee

example of substantive procedures

- obtain analyses of cash balances and reconcile them to general ledger - confirm cash balances with financial institutions - obtain rec of bank balances and consider reconciling bank activity - obtain bank cutoff statement - count cash on hand - verify the client's cutoff of cash transactions - analyze bank transfers occurring year-end - investigate payments to related parties - evaluate financial statement presentation and disclosure

Account payable tests that can be done before balance sheet date

1. accrued property taxes 2. amounts withheld from employees' pay

List of current accounts

Cash Securities Accounts Receivable Inventories Accrued Liabilities Accounts Payable Short-Term Notes

Which assertion relating to sales is most directly addressed when the auditors compare a sample of shipping documents to related sales invoices? Existence or occurrence. Completeness. Rights and obligations. Presentation and disclosure.

Completeness.

Revenue Cycle—Documents

Customer purchase order Sales order Bill of lading Invoice Control listing Credit memo

Types of Kiting Misstatements

Date of recording per transfer per the books are from different financial statement periods Date the check was recorded by the bank is from financial statement period prior to books

Which of the following would most likely be detected by an auditor's review of the client's sales cutoff? Excessive goods returned for credit. Unrecorded sales discounts. Lapping of year-end accounts receivable. Inflated sales for the year.

Inflated sales for the year.

Similar to accounts payable in that understatement of debt is a major potential audit problem

Inherent Risk

Three major subgroups of Property, Plant, and Equipment?

Land Buildings, machinery, equipment and land improvements Natural resources

Cash typically has a small account balance, but auditors devote a large proportion of total audit hours because:

Liabilities, revenues, expenses and most other assets flow through cash Most liquid asset so greater temptation for misappropriation High risk account

Audit implications of Check 21 Act

Need to rely on substitute check for evidence of check Impossible for clients to kite checks (manipulate bank balances to conceal cash shortage)

Reconciliation of the bank account should not be performed by an individual who also: Processes cash disbursements. Has custody of securities. Prepares the cash budget. Reviews inventory reports.

Processes cash disbursements.

Proof of Cash General Information

Reconciles the account balance and reconciles cash transactions during a specified period.

Which of the following is most likely to be an example of fraudulent financial reporting relating to sales? Inaccurate billing due to a lack of controls. Lapping of accounts receivable. Misbilling a client due to a data input error. Recording sales when the customer is likely to return the goods.

Recording sales when the customer is likely to return the goods.

Auditors should obtain from management a list describing and evaluating threatened or pending litigation

SAS 12

Purchasing Function Internal control is what?

Segregation of purchasing, receiving and recording

General checking account Payroll checking accounts Petty cash Savings accounts

Sources of cash

To provide assurance that each voucher is submitted and paid only once, the auditors most likely would examine a sample of paid vouchers and determine whether each voucher is: Supported by a vendor's invoice. Stamped "paid" by the check signer. Prenumbered and accounted for. Approved for authorized purchases.

Stamped "paid" by the check signer.

Fraud Risk related to Receivables and Revenue

Understand controls established by management to control risk Determine controls have been implemented Respond to risk

Specific misstatements identified during the course of the audit

known misstatements

- an electronic image of check

substitute check

Point of inventory observation is to determine existence

true

lADAs enables the auditor to examine extensive data sets spanning longer periods of time and at more disaggregated levels.

true

Storing Function of inventory does what?

Counts, inspects and receives goods Notifies accounting of receipt Physically secures inventory

the science and art of discovering and analyzing patterns, identifying anomalies, and extracting other useful information in data underlying or related to the subject matter of an audit through analysis, modeling, and visualization for the purpose of planning or performing the audit.

The American Institute of Certified Public Accountants (AICPA) has defined audit data analytics as

what do you do when you have a type 2 subsequent event?

consider for disclosure

Types of internal control for inventory

control environment risk assessment monitoring

Accounts for usage of raw materials

cost accounting

Compute finished inventory

cost accounting

Determines content and value of goods in progress

cost accounting

Determine overall reasonableness of interest expense by examining relationship of recorded interest to average principal amount of debt outstanding during year

true

FASB requirements allow companies to choose to use fair value accounting in this area

true

Kiting schemes rely upon the existence of a "float period" in which transactions are not processed in real time; increased electronic processing has made kiting more difficult through reducing (or eliminating the float period).

true

Loss contingencies need not be disclosed when the possibility of loss is remote

true

Study figure 11.5 before exam/quiz

true

The approach to the audit would not have to fundamentally change to incorporate ADAs

true

lAuditors using ADAs are able to perform procedures that may cover 100% of the items in large data populations.

true

material misstatements must be corrected

true

study figure 11.2 before exam/quiz

true

study figure 11.4 before exam/quiz

true

Conditions existing on or before balance sheet date

type 1 subsequent event

conditions arising after balance sheet date

type 2 subsequent event

need to be disclosed if probable and reasonably possible

unasserted claims

Benefits of Using ADAs

- ADAs can provide deeper insights into the organization's systems and controls - ADAs can allow the auditor to perform analysis on 100% of a population rather than use of sampling. - ADAs can provide more robust performance information for management - ADAs can increase in audit quality.

Accrued Liabilities (3 of 3)

- Accrued Property Taxes - Accrued Payrolls - Pension Plan Accruals - Postemployment Benefits other than Pensions - Accrued Vacation Pay - Product Warranty Liabilities - Accrued Commission and Bonuses - Income Tax Payable - Accrued Professional Fees

Audit Documentation of accounts payable

- Lead schedule for accounts payable - Trial balances of various types of accounts payable - Confirmation requests for accounts payable - Listing of unrecorded accounts payable

Qualitative materiality factors are likely material when:

- Arise from an item capable of precise measurement (e.g., the amount of a sale) rather than from an estimate (e.g., the amount in the allowance for doubtful accounts). - Mask a change in earnings or other trends. - Hide a failure to meet analysts' consensus expectations for the company. - Change a loss into income, or vice versa. - Concern a particularly important segment or other portion of the registrant's business. - Affect compliance with regulatory requirements, loan covenants, or other contractual requirements. - Increase management's compensation. - Involve concealment of an unlawful transaction. -Are of an amount that management or the auditors believe would affect the stock's price.

Post-Audit Responsibilities

- Auditor subsequent discovery of facts existing at date of report - Advise client to make appropriate disclosure of the facts to anyone actually or likely to be relying upon the audit report and financial statements - If client refuses to make disclosure, CPA should inform each member of board and notify regulatory agencies

Controls against misstatements for accounts payable

- Auditors found serially numbered receiving reports are prepared - Serially numbered vouchers are prepared - Payments made promptly on due dates - Immediately recorded in accounting records - Independent employee reconciles subledger to general ledger

Internal Control Over Interest-Bearing Debt

- Authorization by the board of directors - Use of an independent trustee - Interest Payments on Bonds and Notes Payable--Cash disbursement controls

Risk Assessment; risks related to Internal Control

- Availability of a supply of goods, services, and skilled labor - Stability of prices and labor rates - Generation of sufficient cash flow to pay for purchases - Changes in technology that affect manufacturing processes - Obsolescence of inventory

Search for Unrecorded A/P

- Be alert during reconciliations, confirmations and analytical procedures for unrecorded liabilities - Examine transactions recorded following year-end - Compare cash payments after year-end to a/p trial balance - Examine cash disbursements over specific dollar amounts during subsequent period

Presentation and Disclosure Disclosure of inventory pricing methods or methods in use Other important disclosures:

- Changes in methods - Classifications of inventory - Details of pledged inventory - Deduction of valuation allowance for inventory losses - Existence and terms of inventory purchase commitments.

Auditor should analyze account to look for items improperly recorded as miscellaneous:

- Collections on previously written-off accounts or notes receivable - Write-offs of old outstanding checks or unclaimed wages - Proceeds from sales of scrap - Rebates or refunds of insurance premiums - Proceeds from sales of plant assets

Standard Confirmation—General Information

- Confirmation of amounts on deposit by direct communication with financial institution officials - Addresses only the client's deposit and loan balances - The confirmation process may be performed electronically if properly controlled

Audit Documentation of Debt and Equity Capital

- Copy of loan agreement or indenture related to bond placed in permanent file - Extract list of restrictions placed on company for auditor to test compliance - Current workpapers - Analyses of ledger accounts for notes and bonds payable - Related accounts of interest and discount or premium

Presentation of accounts payable

- Current liability - Accrued expenses - Deferred income tax for next year - Deferred credits for rent - Deposits on contracts - Long-term liability - Deferred income tax - noncurrent

Customers' Deposits

- Deposits on returnable containers or to guarantee payment of bills - Review procedures followed in accepting and returning deposits - Verify list of individual deposits and compare to general ledger account - Generally do not confirm

Dividends

- Determine the dates and amounts of dividends authorized - Verify the amounts paid - Determine the amount of any preferred dividends in arrears - Review the treatment of unclaimed dividend checks

Subsequent Discovery of Omitted Audit Procedures

- Discovered during peer review or other subsequent review of working papers - Assess importance of omitted procedures to their previously issued opinion - If omission impairs ability to support issued opinion and report being relied upon by third parties, attempt to perform omitted procedure or appropriate alternative procedure

Controls Over Financial Investments

- Establishment of formal investment policies - Review and approval of investment activities by the investment committee of the board of directors - Detailed records of all securities owned and the related revenue from interest and dividends - Registration in the name of the company - Periodic physical inspection of securities - Determination of accounting for complex instruments by competent personnel

Specialized Knowledge to Audit Financial Investments

- Identifying controls at service organizations that provide financial services and are part of the client's information system. - Obtaining an understanding of information systems for securities and derivatives that are highly dependent on computer technology. - Applying complex accounting principles to various types of financial investments. - Understanding the methods used to determine the fair values of financial investments, especially those that must be valued using complex valuation models. - Assessing inherent and control risk for assertions about derivatives used in hedging activities.

Other Contingencies

- Income tax disputes - Accommodation endorsements and other guarantees of indebtedness - Accounts receivable sold or assigned with recourse - Environmental issues - Commitments - General risk contingencies

Amounts withheld from employees' pay

- Income taxes withheld from employees' pay but not remitted as of balance sheet date - Trace amounts withheld to payroll summary sheets - Test computations of taxes withheld and accrued - Determine that taxes have been deposited in accordance with law

Loss contingencies should be reflected in the financial statement amounts when:

- It is probable that a loss had been sustained before the balance sheet date - The amount of the loss can be reasonably estimated

Impairment of Long-Lived Assets

- Long-lived assets must be reviewed for impairment whenever events or changes in circumstances indicate that carrying value may not be recoverable - Test involves projecting future cash flows - If impairment is indicated by cash flows asset must be written down to fair value - May require the use of a valuation specialist

Potential Misstatements—Financial Investments

- Misstatement of recorded value of investments - Unauthorized investment transactions - Incomplete recording of investments - Inadequate disclosure of the nature of - investment activities

Adjusting entry needed? for unrecorded accounts payable

- Misstatements and omissions are judged based on impact on the financial statements - Materiality - Effect on net income - Need to consider cumulative effect on the financial statements

Time of Examination of accounts payable

- Most effective when performed immediately after the balance sheet date - Little value if done before because concern with understatements

List of Audit of PPE—Advance Work

- Most work can be done in advance - Consideration of internal control can be carried out at any convenient time - Many firms audit during interim work in October and November - After balance sheet date, only need to exam transaction for final two or three months

Accrued Liabilities (1 of 3)

- Obligations payable sometime during the succeeding period for services or privileges received before balance sheet date - Examples: Interest payable, accrued property taxes - Accounting estimates -Review and test management's process of developing the estimate -Review subsequent events -Independently develop estimate to compare

Substantive Tests of Interest- Bearing Debt (1 of 6)

- Obtain analyses of interesting-bearing debt and related accounts - examine copies of notes payable and supporting documents - confirm interest-bearing debt - vouch borrowing and repayment transactions - perform analytical procedures - Test computations of interest expense, interest payable, and amortization of discount premium - evaluate compliance with debt provisions - verify authority for issuance of debt to corporate minutes - review notes payable paid or renewed after the balance sheet date - perform procedures to identify notes payable to related parties - send confirmation letters about financing arrangements - evaluate financial statement presentation and disclosure - evaluate financial statement presentation and disclosure

Some Uses of Audit Data Analytics

- Peer analysis - Three-way match procedure - Journal entry analytic - Segregation of duties analysis - General ledger account reconciliation - Account balance analysis

Internal Control - Capital Stock

- Proper authorization of transactions by board of directors an corporate officers - Segregation of duties in handling transactions - Maintenance of adequate records - Board of director control of capital stock transactions - Large companies—Independent registrar and stock transfer agent control issuance of stock - Small companies--Control achieved by segregation of duties of authorization of transactions, custody of stock certificates, and record-keeping - Stock certificate book - Stockholders' ledger - Control over dividend payment

Acquisition Cycle—Documents for accounts payable

- Purchase order - Receiving report - Vendor's invoice - Vendor's statement

Natural Resources similar to depreciation steps

- Recorded consistently and in accordance with GAAP - Test mathematical accuracy - Often rely on specialists for valuation - Establish ownership

Sales Tax Payable

- Required to collect sales tax imposed by state and local governments - Not an expense, just collecting agent - Liabilities until remitted - Verify liability by reviewing tax return - Test reasonableness of amount - Test invoices for correct tax charge

Review 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

Problems with First Year Clients Procedures to obtain evidence that beginning inventory is fairly stated

- Review predecessor's working papers - Discuss with person who supervised physical inventory at beginning - Study written instructions in planning - Trace numerous items from inventory tags to final summary sheets - Test perpetual inventory records for previous year - Test overall reasonableness of beginning inventory

Evaluation Materiality: Considering Previous Year Uncorrected Misstatements

- SEC SAB 108 Situation: - $70,000 current year misstatement - $60,000 balance sheet carryover from preceding year - If either the $70,000 or the $130,000 total ($70,000 + 60,000) is material to this year, an adjustment must be made. - The current year's income is decreased by at least $70,000 - If the $60,000 is immaterial this year, it will also decrease current year income - If the $60,000 is material this year, prior year financial statements should be adjusted.

Controls Over the Conversion Cycle

- Segregation of duties over purchases and custody of inventory - Use of pre-numbered requisitions, purchase orders, and receiving reports - Procedures for authorizing purchase transactions and verifying them for payment - General ledger control of inventories and reconciliation to production records - Cost accounting controls - Analysis of variances from standard costs - Use of perpetual records for inventories - Use of appropriate procedures for taking inventory - Appropriate physical controls over inventories

Controls Over the Acquisition Cycle for accounts payable

- Segregation of duties—purchases and disbursements - Approval of purchase orders - Numerical control of purchase orders and receiving reports - Matching of details of vendors' invoices to purchase orders and receiving documents - Approval of vendors' invoices - Pre-numbered checks - Reconciliation of details of individual disbursements to controlling accounts - Reconciliation of vendors' statements to accounts - Reconciliation of bank accounts - Use of budgets and analysis of variances - Use of chart of accounts and review of account coding

Considerations in Planning a Physical Inventory

- Selecting of the appropriate date - Suspending production - Segregating obsolete and defective goods - Establishing control over the counting process - Achieving proper cutoff of sales and purchases - Arranging for the services of specialists

Shipping function of inventory does what?

- Shipment upon authorized sales order approved by credit department - Generates a prenumbered shipping document - One copy in shipping - One copy to billing - Third copy used as packing slip - For goods shipped common carrier - fourth copy services as bill of lading

Sources of Accounts Payable

- Short-term obligations arising from purchase of goods and services in ordinary course of business; examples: - Acquisition of merchandise on credit -Receipt of services such as advertising, repairs - Invoices and statements from suppliers usually evidence accounts payable - Interest-bearing obligations are not included in accounts payable; they are included as bonds, notes, etc.

McKesson & Robbins Fraud Case

- Significant impact on responsibility of auditors with respect to validity of inventories - Case: 1939 - the audited financial statements contained $19 million of fictitious assets including $10 million of nonexistent inventories - Auditors followed customary auditing practice which limited audit work on inventories to examining records only - Statements on Auditing Procedures 1 and 2 - first formal auditing standards issued by AICPA affirmed the importance of auditors' observation of physical inventories although other auditing procedures could be substituted

timing of examination for debt and equity

- Small number of entries - End of the year - often wait until after balance sheet date for many procedures - Test for unrecorded liabilities cannot usually be done before the balance sheet date - Evaluation of compliance with debt provisions - Tests of interest expense -Investigation of notes paid after year-end

Issuing and production function of inventory does what?

- Stores department issues goods to requesting department - Prenumbered requisition Production - Controlled with master production schedule - Production orders - Materials requisitions and move tickets - Job time tickets

Unclaimed wages

- Subject to misappropriation - Concerned with adequacy of internal control -Should not be left for more than a few days -Prompt deposit in special bank account - Analyze unclaimed wages to determine -Credit represents all unclaimed wages after each payroll distribution -Debits represent authorized payments

Risks of misstatements of accounts payable

- Subsidiary records not in agreement with general ledger - Receiving reports and vouchers used haphazardly - Purchase transactions often not recorded until payment is made - Many accounts payable long past due *Risks such as these indicate the need for extensive substantive procedures

The Special Significance of Audit of Inventories

- The valuation of goods on hand and in process often presents complex and difficult issues - Determining the quantities of inventories may require specialized techniques - Inventories often represent the largest current asset of a company - Misstatements of inventories directly affect cost of goods sold and, therefore, net income - Management fraud has often involved the fraudulent overstatement of inventories

Controls Over Plant and Equipment

- Use of a plant and equipment capital budget - Maintenance of a subsidiary ledger - A system of authorizations - Analysis of variances from budgeted expenditures - A statement of policy distinguishing between capital and revenue expenditures - A requirement that purchases of plant and equipment are subjected to normal purchasing procedures - Periodic physical inventories - A system of retirement authorization and documentation

How to Evaluate compliance with debt provisions?

- Vouch payments to sinking fund - Maintenance of stipulated minimum levels of working capital - Examine evidence of insurance of pledged property - Compare amounts of management compensation and dividends paid to amounts allowed by agreements

Inventory Pricing Emphasizes what?

- What method of pricing does the client use? - Is the method of pricing the same as that used in prior years? - Has the method selected by the client been applied consistently and accurately in practice? - Test the pricing of inventories

Internal Control over A/R and Revenue

- control environment - risk assessment - control activities

Potential Misstatements—Accounts Payable Figure 14.4

- inaccurate recording of a purchase or disbursement - misappropriation of purchases - duplication recording of purchases - late (early) recording of cost of purchases - "cutoff problems"

Types of Audit Documentation for Revenue cycle

- lead schedules for receivables and net revenue - working papers

Potential Misstatements—Investments in Property, Plant, and Equipment Figure 13.3

- misstatement of acquisitions of property, plant, and equipment - failure to record retirements of property, plant, and equipment - improper reporting of unusual transactions

Summary of Substantive Tests of Property, Plant, and Equipment Figure 13.2

- obtain a summary analysis of changes in property owned and reconcile to ledgers - vouch additions during year. Make physical inspection of major acquisitions - analyze repair and maintenance expense accounts - investigate the status of property not in current use - test the client's provision for depreciation. Investigate potential impairments - investigate retirements of property during the year. Examine evidence of legal ownership. Review rental revenue - examine lease agreements. Perform analytical procedures - evaluate financial statement presentation and disclosure

Substantive Tests of Capital Stock

- obtain analyses of capital stock accounts - including treasury stock - account for proceeds of stock issues - confirm shares outstanding - request written by client on client's letterhead but mailed by auditors - reconcile shares outstanding with general ledger - accounting for stock certificate numbers - examining canceled certificates - reconciling the stockholders ledger and stock certificate book with the general ledger - determine the appropriate accounting is applied to employee stock compensation plans - accounting at fair value - Determine compliance with restrictions and preferences related to capital stock and disclosures are appropriate - stock options

Summary of Substantive Procedures for Financial Investments Figure

- obtain analysis of investments and related accounts to reconcile to ledger - inspect securities on hand and review agreements underlying derivatives - confirm securities and derivative instruments with holders and counterparties - vouch selected purchases and sales of investments during the year - verify the client's cutoff of investment transactions - review investments committee minutes and reports - perform analytical procedures - make independent computations of revenue from securities - inspect documentation of management's intent to classify derivative transactions as hedges - evaluate the method of accounting for investments - test the valuation of financial investments -evaluate financial statement presentation and disclosure of financial investments

Summary of Substantive Tests of Accounts Payable

- obtain trial balance of payables and reconcile with the ledgers - vouch balances payable to selected creditors by inspecting supporting documents - reconcile liabilities with creditor's monthly statements. - confirm accounts payable - perform analytical procedures - search for unrecorded accounts payable - perform procedures to identify accounts payable to related parties - evaluate financial statement presentation and disclosure

Substantive Tests for Selling, General and Administrative Expenses (1 of 2)

- perform analytical procedures - obtain or prepare analyses of selected expense accounts - obtain or prepare analyses of critical expenses in the income tax return

potential misstatement examples - cash receipts

- recording fictitious cash receipts - failure to record receipts from cash sales - failure to record cash from collection of accounts receivable - early (late) recognition of cash receipts *cutoff problems*

Guidelines for Internal Control

1. Do not permit any one employee to handle a transaction from beginning to end. 2. Separate cash handling from recordkeeping. 3. Centralize receiving of cash to the extent practical. 4. Record cash receipts on a timely basis. 5. Encourage customers to obtain receipts and observe cash register totals. 6. Deposit cash receipts daily. 7. Make all disbursements by check or electronic funds transfer, with the exception of small expenditures from petty cash. 8. Have monthly bank reconciliations prepared by employees not responsible for the issuance of checks or custody of cash. The completed reconciliation should be reviewed promptly by an appropriate official. 9. Monitor cash receipts and disbursements by comparing recorded amounts to forecasted amounts

Steps to discover unrecorded retirements:

1. For new additions, determine status of old equipment 2. Analyze miscellaneous revenue account for cash proceeds 3. If company's products discontinued, investigate disposition of plant facilities 4. Inquire of executives and supervisors of plant asset retirements 5. Examine retirement work orders for proper authorization 6. Investigate any reduction in insurance coverage

Risks of Material Misstatements

1. Inventories constitute a large asset and very susceptible to major errors and fraud. 2. The accounting profession allows numerous alternative methods for valuation of inventories, and different methods may be used for various classes of inventories. 3. The determination of inventory value directly affects the cost of goods sold and has a major impact on net income for the year. 4. The determination of inventory quality, condition, and value is inherently a more complex and difficult task than is the case with most other elements of financial position.

Audit Plan - Depreciation Overall test?

1. List the balances in the various asset accounts at the beginning of the year. 2. Deduct any fully depreciated assets, since these items should no longer be subject to depreciation. 3. Add one-half of the asset additions for the year. 4. Deduct one-half of the asset retirements for the year (exclusive of any fully depreciated assets).

E. Perform further audit procedures—substantive procedures for receivables and revenue.

1. Obtain an aged trial balance of trade accounts receivable and analyses of other accounts receivable and reconcile to ledgers. 2. Obtain analyses of notes receivable and related interest. 3. Inspect notes on hand and confirm those with holders. 4. Confirm receivables with debtors. 5. Review the year-end cutoff of sales transactions. 6. Perform analytical procedures for accounts receivable, notes receivable, and revenue. 7. Review significant year-end sales contracts for unusual terms. 8. Test the valuation of notes receivable, computation of interest income, interest receivable, and amortization of discount or premium. 9. Evaluate the propriety of the client's accounting methods for receivables and revenue. 10. Evaluate accounting estimates related to revenue recognition. 11. Determine the adequacy of the client's allowance for uncollectible accounts. 12. Ascertain whether any receivables have been pledged. 13. Investigate any transactions with or receivables from related parties. 14. Evaluate the business purpose of significant and unusual sales transactions. 15. Evaluate financial statement presentation and disclosure of receivables and revenue.

Perform further audit procedures—substantive procedures for cash transactions and balances. (Individual steps)

1. Obtain analyses of cash balances and reconcile them to the general ledger. 2. Confirm cash balances with financial institutions. 3. Obtain or prepare reconciliations of bank (financial institution) accounts as of the balance sheet date and consider the need to reconcile bank activity for additional months. 4. Obtain a cutoff bank statement containing transactions of at least seven business days subsequent to balance sheet date. 5. Count and list cash on hand. 6. Verify the client's cutoff of cash receipts and cash disbursements. 7. Analyze bank transfers for the last week of audit year and the first week of following year. 8. Investigate any checks representing large or unusual payments to related parties. 9. Evaluate proper financial statement presentation and disclosure of cash.

Separation of duties among employees over financial investments

Authorizing purchases and sales Having custody of the securities Maintaining records

E. Perform further audit procedures—substantive procedures for investment transactions and year-end balances. (Audit of financial investments)

1. Obtain or prepare analyses of the investment accounts and related revenue, gain, and loss accounts and reconcile them to the general ledger. 2. Inspect securities on hand and review agreements underlying derivatives. 3. Confirm securities and derivative instruments with holders and counterparties. 4. Vouch selected purchases and sales of financial investments during the year and verify the client's cutoff of investment transactions. 5. Review investment committee minutes and reports.

Purchasing function cycle

1. Purchase requisition form completed by department 2. Purchasing prepares purchase order - May obtain bids but need approval - Item description and quantity - Copy forwarded to accounting - Copy forwarded to receiving should not include quantity

Functions related to inventories

1. Purchasing 2. Receiving 3. Storing 4. Issuing 5. Processing 6. Shipping

Audit Plan (Program) - Depreciation

1. Review the depreciation policies set forth in company manuals or other management directives. Determine whether the methods in use are designed to allocate costs of plant and equipment assets systematically over their service lives. a. Inquire whether any extra working shifts or other conditions of accelerated production are present that might warrant adjustment of normal depreciation rates. b. Discuss with executives the possible need for recognition of obsolescence resulting from technological or economic developments. 2. Obtain or prepare a summary analysis (see Figure 13.1) of accumulated depreciation for the major property classifications as shown by the general ledger control accounts, listing beginning balances, provisions for depreciation during the year, retirements, and ending balances. a. Compare beginning balances with the audited amounts in last year's working papers. b. Determine that the totals of accumulated depreciation recorded in the plant and equipment subsidiary records agree with the applicable general ledger controlling accounts. 3. Test the provisions for depreciation. a. Compare rates used in the current year with those employed in prior years and investigate any variances. b. Test computations of depreciation provisions for a representative number of units and trace to individual records in the property ledger. Be alert for excessive depreciation on fully depreciated assets. Generalized audit software can be used to test the depreciation calculations in the client's records if the client maintains computer based records. c. Compare credits to accumulated depreciation accounts for the year's depreciation provisions with debit entries in related depreciation expense accounts. 4. Test deductions from accumulated depreciation for assets retired. a. Trace deductions to the working paper analyzing retirements of assets during the year. b. Test the accuracy of accumulated depreciation to date of retirement. 5. Perform analytical procedures for depreciation. a. Compute the ratio of depreciation expense to total cost of plant and compare with prior years. b. Compare the percentage relationships between accumulated depreciation and related property accounts with those prevailing in prior years. Discuss significant variations from the normal depreciation plan with appropriate members of management.

Audit Procedures for Loss Contingencies

1. Review the minutes of directors' meetings to the date of completion of fieldwork. 2. Send letter of inquiry to client's lawyer 3. Send confirmation letters to financial institutions to request information on contingent liabilities of the company. 4. Review correspondence with financial institutions for evidence of accommodation endorsements, guarantees of indebtedness, or sales or assignments of accounts receivable. 5. Review reports and correspondence from regulatory agencies to identify potential assessments or fines. 6. Obtain a representation letter from the client indicating that all liabilities known to officers are recorded or disclosed.

Objectives for the Audit Cash

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to cash 2. Obtain an understanding of internal control over cash. 3. Assess the risks of material misstatement of cash and design tests of controls and substantive procedures that:

Objectives for the Audit of Financial Investments

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to financial instruments 2. Obtain an understanding of internal control over financial instruments. 3. Assess the risks of material misstatement of financial instruments and design tests of controls and substantive procedures that:

Objectives for the Audit of Property, Plant and Equipment

1. Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to property, plant, and equipment. 2. Obtain an understanding of internal control over property, plant, and equipment. 3. Assess the risks of material misstatement and design tests of controls and substantive procedures that: Substantiate the existence of property, plant, and equipment Establish the completeness of recorded property, plant, and equipment Verify the cutoff of transactions affecting property, plant, and equipment Determine that the client has rights to recorded property, plant, and equipment Establish the proper valuation or allocation of property, plant, and equipment and the accuracy of transactions affecting property, plant, and equipment Determine that the presentation and disclosure of property, plant, and equipment are appropriate

Inventory objectives

1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to inventories and cost of goods sold. 2. Obtain an understanding of internal control over inventories and cost of goods sold. 3. Assess the risks of material misstatement and design tests of controls and substantive procedures that: a. Substantiate the existence of inventories and the occurrence of transactions affecting cost of goods sold. b. Establish the completeness of recorded inventories. c. Verify the cutoff of transactions affecting cost of goods sold. d. Determine that the client has rights to the recorded inventories. e. Establish the proper valuation of inventories and the accuracy of transactions affecting cost of goods sold. f. Determine that the presentation and disclosure of information about inventories and cost of goods sold are appropriate, including disclosure of the classification of inventories, accounting methods used, and inventories pledged as collateral for debt.

Objectives for audit of revenue and expenses

1. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to revenues and expenses. 2. Consider internal control over revenues and expenses. 3. Assess the risks of material misstatement of revenues and expenses and design further audit procedures that: a. Establish the occurrence of recorded revenue and expense transactions. b. Determine the completeness of recorded revenue and expense transactions. c. Establish the accuracy of revenue and expense transactions. d. Verify the cutoff of revenue and expense transactions. e. Determine that the presentation and disclosure of revenue and expense accounts are appropriate, including the proper classification of amounts and the proper presentation of earnings-per-share data.

1. Only material accounts need be confirmed. 2. If the misstatements identified by the confirmation process are in total immaterial, the auditors may still conclude that the account is materially overstated. 3. Confirmation replies should be addressed directly to the CPAs at the client's address. 4. Confirmations address completeness more than they address existence. 5. Confirmation of accounts receivables may be omitted in certain circumstances. 6. A combination of positive and negative requests may be used.

1. incorrect 2. correct 3. incorrect 4. incorrect 5. correct 6. correct

Objectives for the Audit of Interest-Bearing Debt

1.Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to debt. 2.Obtain an understanding of internal control over debt. 3.Assess the risks of material misstatement of and design tests of controls and substantive procedures that: a.Substantiate the existence of debt and the occurrence of the related transactions b.Establish the completeness of recorded debt c.Verify the cutoff of transactions affecting debt d.Determine that the client has obligations to pay the recorded debt e.Establish the proper valuation of debt and the accuracy of transactions affecting debt f.Determine that the presentation and disclosure of debt are appropriate

Objectives for the Audit of Owners' Equity

1.Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to owners' equity. 2.Obtain an understanding of internal control over owners' equity. 3.Assess the risks of material misstatement of and design tests of controls and substantive procedures that: a.Substantiate the existence of owners' equity and the occurrence of the related transactions b.Establish the completeness of recorded owners' equity c.Verify the cutoff of transactions affecting owners' equity d.Determine that the client has obligations to pay the recorded debt e.Establish the proper valuation of owners' equity and the accuracy of transactions affecting owners' equity f.Determine that the presentation and disclosure of owners' equity are appropriate

E. further audit procedures cont.

6. Perform analytical procedures. 7. Make independent computations of revenue from securities. 8. Inspect documentation of management's intent to classify derivative transactions as hedging activities. 9. Evaluate the method of accounting for investments. 10. Test the valuation of financial investments. 11. Evaluate financial statement presentation and disclosure of financial investments.

Which of the following controls would most likely reduce the risk of diversion of customer receipts by a client's employees? A bank lockbox system. Prenumbered remittance advices. Monthly bank reconciliations. Daily deposit of cash receipts.

A bank lockbox system.

Audit of Financial Investments

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks related to financial investments. B. Obtain an understanding of internal control over financial investments C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. E. Perform further audit procedures—substantive procedures for investment transactions and year-end balances.

Audit of Cash steps

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to cash. B. Obtain an understanding of internal control over cash. C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. E. Perform further audit procedures—substantive procedures for cash transactions and balances.

Audit Steps for inventory

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to inventories and cost of goods sold. B. Obtain an understanding of internal control over inventories and cost of goods sold. C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. 1. Examples of tests of controls: a. Examine significant aspects of a sample of purchase transactions. b. Perform tests of the cost accounting system. 2. If necessary, revise the risks of material misstatement based on the results of tests of controls. E. Perform further audit procedures—substantive procedures for inventories and cost of goods sold. 1. Obtain listings of inventory and reconcile to ledgers. 2. Evaluate the client's planning of physical inventory. 3. Observe the taking of physical inventory and make test counts. 4. Review the year-end cutoff of purchases and sales transactions. 5. Obtain a copy of the completed physical inventory, test its clerical accuracy, and trace test counts. 6. Evaluate the bases and methods of inventory pricing. 7. Test the pricing of inventories. 8. Perform analytical procedures. 9. Determine whether any inventories have been pledged and review purchase and sales commitments. 10. Evaluate financial statement presentation of inventories and cost of goods sold, including the adequacy of disclosure.

PPE Audit Steps (1 of 3)

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to property, plant, and equipment. B. Obtain an understanding of internal control over property, plant, and equipment. C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. 1. Nature of tests of controls. 2. If necessary, revise the risks of material misstatement based on the results of tests of controls. E. Perform further audit procedures—substantive procedures for property, plant, and equipment. 1. Obtain a summary analysis of changes in property owned and reconcile to ledgers. 2. Vouch additions to property, plant, and equipment during the year. 3. Make a physical inspection of major acquisitions of plant and equipment. 4. Analyze repair and maintenance expense accounts. 5. Investigate the status of property, plant, and equipment not in current use. 6. Test the client's provision for depreciation. 7. Investigate potential impairments of property, plant, and equipment. 8. Investigate retirements of property, plant, and equipment during the year. 9. Examine evidence of legal ownership of property, plant, and equipment. 10. Review rental revenue from land, buildings, and equipment owned by the client but leased to others. 11. Examine lease agreements on property, plant, and equipment leased to and from others. 12. Perform analytical procedures for property, plant, and equipment. 13. Evaluate financial statement presentation and disclosure for plant assets and for related revenue and expenses.

Receivables Audit Steps

A. Use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to receivables and revenue. B. Obtain an understanding of internal control over receivables and revenue. C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. E. Perform further audit procedures - substantive procedures for receivables and revenue

Accounts Payable Audit Steps (1 of 4)

A.Use the understanding of the client and its environment to consider inherent risks , including fraud risks, related to accounts payable. B. Obtain an understanding of internal control over accounts payable. C. Assess the risks of material misstatement and design further audit procedures. D. Perform further audit procedures—tests of controls. 1. Examples of tests of controls. a. Verify a sample of postings to the accounts payable control account. b. Vouch to supporting documents a sample of postings in selected accounts of the accounts payable subsidiary ledger. c. Test IT application controls. d. If necessary, revise the risks of material misstatement based on the results of tests of controls. E. Perform further audit procedures—substantive procedures for accounts payable. 1. Obtain or prepare a trial balance of accounts payable as of the balance sheet date and reconcile with the general ledger. 2. Vouch balances payable to selected creditors by inspection of supporting documents. 3. Reconcile liabilities with monthly statements from creditors. 4. Confirm accounts payable by direct correspondence with vendors. 5.Perform analytical procedures for accounts payable and related accounts. 6. Search for unrecorded accounts payable. 7. Perform procedures to identify accounts payable to related parties. 8. Evaluate proper balance sheet presentation and disclosure of accounts payable.

Standard form agreed to by:

AICPA American Bankers Association Bank Administration Institute

Shown on balance sheet at net realizable value

Accounts Receivable

Receivables should be confirmed, unless:

Accounts receivable are immaterial, The use of confirmations would be ineffective, or The auditors' combined assessment of inherent and control risk is low, and audit risk can be reduced to acceptably low level with substantive tests

To test the existence assertion for recorded receivables, the auditors would select a sample from the: Sales orders file. Customer purchase orders. Accounts receivable subsidiary ledger. Shipping documents (bills of lading) file.

Accounts receivable subsidiary ledger.

The auditors who physically examine securities should insist that a client representative be present in order to: Detect fraudulent securities. Lend authority to the auditors' directives. Acknowledge the receipt of securities returned. Coordinate the return of securities to the proper locations.

Acknowledge the receipt of securities returned.

Finance and accounting department work together to provide assurance that:

All cash that should have been received was in fact received, recorded accurately and deposited promptly Cash disbursements have been made for authorized purposes only and have been properly recorded Cash balances are maintained at adequate, but not excessive, levels by forecasting

FASB requirements for derivative instruments and hedging activities:

All derivative instruments valued at fair values Unrealized gains or losses depend on classification as hedges

Hall Company had large amounts of funds to invest on a temporary basis. The board of directors decided to purchase securities and derivatives and assigned the future purchase and sale decisions to a responsible financial executive. The best person or persons to make periodic reviews of the investment activity would be: An investment committee of the board of directors. The chief operating officer. The corporate controller. The treasurer.

An investment committee of the board of directors.

The auditors should confirm accounts receivable unless the auditors' assessment of the risk of material misstatement is low: And accounts receivable are immaterial, or the use of confirmations would be ineffective. And accounts receivable are composed of large accounts. And the effectiveness of confirmations is absolutely determined. Or accounts receivable are from extremely reputable customers.

And accounts receivable are immaterial, or the use of confirmations would be ineffective.

Which of the following would provide the most assurance concerning the valuation of accounts receivable? Trace amounts in the accounts receivable subsidiary ledger to details on shipping documents. Compare receivable turnover ratios to industry statistics for reasonableness. Inquire about receivables pledged under loan agreements. Assess the allowance for uncollectible accounts for reasonableness.

Assess the allowance for uncollectible accounts for reasonableness.

Accrued Liabilities (2 of 3)

Basic audit steps 1. Examine any contracts or other documents on hand that provide the basis for the accrual. 2. Appraise the accuracy of the detailed accounting records maintained for this category of liability. 3. Identify and evaluate the reasonableness of the assumptions made that underlie the computation of the liability. 4. Test the computations made by the client in setting up the accrual. 5. Determine that accrued liabilities have been treated consistently at the beginning and end of the period. 6. Consider the need for accrual of other accrued liabilities not presently considered (that is, test completeness). 7. For significant estimates, perform a retrospective analysis of the prior year's estimates for evidence of management bias.

Initial Audits start with what?

Beginning balances - Substantiated by review of predecessor firm's working papers - If not previously audited, a complete historical analysis of property accounts is needed - Thorough review of all major charges and credits to property accounts

Proof of Cash General Information is used to identify what?

Cash receipts and disbursements recorded in the accounting records, but not on the bank statement. Cash deposits and disbursements recorded on the bank statement, but not on the accounting records. Cash receipts and disbursements recorded at different amounts by the bank than in the accounting records.

Checks may be processed electronically Electronic processing creates a substitute check Legal equivalent of original check for all purposes

Check 21 Act

Sources of Accounts Receivable

Claims against customers from sale of goods Loans to officers or employees Loans to subsidiaries Claims against various other refunds Claims for tax refunds Advances to suppliers

Inventory Observation

Client counts and supervises inventory Auditors observe - Determine all items included - Employees comply with instructions - Be alert for inclusion of obsolete or damaged merchandise - Record numbers of final receiving and shipping documents issued before inventory taking - Make test counts - Tag control

Internal Control Control Environment

Commitment to competence and human resource policies and practices - Appropriately qualified and trained personnel assigned to inventory Integrity and ethical values - Company purchasing agents do not accept "kickbacks" Organizational structure and assignment of authority and responsibility - Purchasing, receiving and production understand roles

Develop estimate and evaluate reasonableness of management estimate

Compare the details of the aging of accounts receivable to prior years' aging. Investigate the credit ratings for delinquent and unusually large accounts. Review confirmation exceptions for an indication of amounts in dispute or other clues as to possible uncollectible accounts. Summarize in a working paper those accounts whose collectability is doubtful based on the preceding procedures. List customer names, doubtful amounts, and reasons for considering these accounts doubtful. Review with the credit manager the current status of significant doubtful accounts Compute relationships, such as the number-of-days'-sales in accounts receivable and the relationship of the valuation allowance to (1) accounts receivable and (2) net credit sales.

Which assertion relating to sales is most directly addressed when the auditors compare a sample of shipping documents to related sales invoices? Existence or occurrence. Completeness. Rights and obligations. Presentation and disclosure.

Completeness.

You have been assigned to the year-end audit of a financial institution and are planning the timing of audit procedures relating to cash. You decide that it would be preferable to: Count the cash in advance of the balance sheet date in order to disclose any kiting operations at year-end. Coordinate the count of cash with the cutoff of accounts payable. Coordinate the count of cash with the count of marketable securities and other negotiable assets. Count the cash immediately upon the return of the confirmation letters from the financial institution.

Coordinate the count of cash with the count of marketable securities and other negotiable assets.

Auditor must determine whether company has met all requirements and restrictions of debt agreement

true

Under SEC rules, which of the following is not among the criteria that ordinarily exist for revenue to be recognized? Collectibility is reasonably assured. Delivery has occurred or is scheduled to occur in the near future. Persuasive evidence of an arrangement exists. The seller's price to the buyer is fixed or determinable.

Delivery has occurred or is scheduled to occur in the near future.

The auditors suspect that a client's cashier is misappropriating cash receipts for personal use by lapping customer checks received in the mail. In attempting to uncover this embezzlement scheme, the auditors most likely would compare the: Details of bank deposit slips with details of credits to customer accounts. Daily cash summaries with the sums of the cash receipts journal entries. Individual bank deposit slips with the details of the monthly bank statements. Dates uncollectible accounts are authorized to be written off with the dates the write-offs are actually recorded.

Details of bank deposit slips with details of credits to customer accounts.

Investigate Retirements

Determine if property sold, dismantled, or abandoned without being reflected in accounting records

Receiving function of inventory does what?

Determines quantity of goods received Detects damaged or defective merchandise Prepares receiving report Prompt transmittal of goods received to stores department

Proper Cut-off of Inventory

Examine on a test basis the purchase invoices and receiving reports for several days before and after the inventory date. - Determine that liability has been recorded for all goods in inventory - Make sure shipments and purchases recorded in proper period

Money market funds Certificates of deposit Savings certificates

Examples of Cash equivalents

Activities of company designed to obtain capital funds

Financing Cycle

To gather evidence regarding the balance per bank in a bank reconciliation, the auditors would examine any of the following except: Cutoff bank statement. Year-end bank statement. Bank confirmation. General ledger.

General ledger.

Source of Inventories

Goods on hand ready for sale Goods in the process of production Goods to be consumed directly or indirectly in production such as raw materials, purchased parts and supplies

How to respond to risk relating to receivables and revenue

Has overall effect on audit Design of audit procedures Performing procedures to address risk of material misstatement due to management override of internal control

Audit Approach—Current Accounts Versus Noncurrent Account

High turnover accounts Audit approach—audit the balance vs. Low turnover accounts Audit approach—audit the changesin the accounts

Control Environment for A/R and Revenue

Important because of risk of intentional misstatement of revenue Commitment to integrity and ethical behavior Independence of board and audit committee Appropriate structure and lines of responsibility Commitment to recruit, develop, and retain competent employees Holding employees accountable

Collections of receivables internal controls

Initial listing of cash receipts Custody and depositing of cash receipts Maintenance of customer account records Reconciliation of customers' ledgers with control accounts Mailing monthly statements to customers Collection activity and past-due accounts Direct receipt of funds by financial institution

When the Auditors are Engaged after Year-End

Inventory verification when auditor unable to observe taking of inventory at close of year. - May conclude that sufficient appropriate evidence cannot be obtained to express an opinion - Or could obtain satisfaction with alternative auditing procedures - Existence of strong internal control - Perpetual inventory records - Documentation of well-planned and executed physical inventory - Making of test counts

Cash sales internal controls

Involvement of two or more employees Cash Registers Electronic point of sales systems

Activities of company designed to obtain capital funds

Involves issuance and repayment of debt and equity Payment of interest and dividends

In testing controls over cash disbursements, the auditors most likely would determine that the person who signs checks also : Reviews the monthly bank reconciliation. Returns the checks to accounts payable. Is denied access to the supporting documents. Is responsible for mailing the checks.

Is responsible for mailing the checks.

Audit risk significant because

Many incidences of fraud have involved overstatement of receivables and revenue Revenue recognition may be based on complex accounting rules Receivables and revenues are usually subject to valuation using significant accounting estimates

Which of the following procedures would the auditors most likely perform to test controls relating to management's assertion about the completeness of cash receipts for cash sales at a retail outlet? Observe the consistency of the employees' use of cash registers and tapes. Inquire about employees' access to recorded but undeposited cash. Trace deposits in the cash receipts journal to the cash balance in the general ledger. Compare the cash balance in the general ledger with the bank confirmation request.

Observe the consistency of the employees' use of cash registers and tapes.

Which of the following is least likely to be considered an inherent risk relating to receivables and revenues? Restrictions placed on sales by laws and regulations. Decline in sales due to economic declines. Decline in sales due to product obsolescence. Over-recorded sales due to a lack of control over the sales entry function.

Over-recorded sales due to a lack of control over the sales entry function.

Other functions

Perpetual inventory system -Provide information essential to purchasing, sales and production-planning policies - Allows companies to control high costs of holding excessive inventory IT systems - Easier to control inventories - EDI to coordinate production and purchasing

SEC Staff Accounting Bulletin No. 104.

Persuasive evidence of an arrangement exists Delivery has occurred or services have been rendered The seller's price to the buyer is fixed or determinable Collectability is reasonably assured

Documentation of Physical Inventory

Plan should be documented and communicated in form of written instructions to personnel taking physical inventory - Letter from client reviewed by auditors - Auditors consider nature and materiality of inventories - Date is typically at or near balance sheet date unless internal control is effective

Control Activities Division of duties

Prepare sales order Approve credit Issue merchandise from stock Shipment Billing Invoice verification Maintenance of control accounts Maintenance of customers' ledgers Approval of sales returns and allowances Authorization of write-offs of uncollectible accounts

Primary concern for Financing cycle

Proper authorization by appropriate official in the company or by board of directors

List of noncurrent accounts

Property, Plant & Equipment Intangible Assets Long-Term Liabilities Owner's Equity Accounts

Tangible assets with a service life of more than one year that are used in the operation of the business and are not acquired for the purpose of resale

Property, Plant and Equipment

To identify related party transactions, auditors should review what?

Proxy and other filings with SEC or other regulatory agencies conflict-of-interest statements by management Transactions with unusual terms Accounting records for unusual balances or transactions particularly near year-end

Analytical Procedures for PPE

Ratios and trends for overall reasonableness of recorded amounts a. Total cost of plant assets divided by annual output in dollars, pounds, or other units. b. Total cost of plant assets divided by cost of goods sold. c. Comparison of repairs and maintenance expense on a monthly basis and from year to year. d. Comparison of acquisitions for the current year with prior years. e. Comparison of retirements for the current year with prior years.

Debt and Equity Capital has Inherent risk

true

In order to guard against the misappropriation of company-owned marketable securities, which of the following is the best course of action that can be taken by a company with a large portfolio of marketable securities? Require that one trustworthy and bonded employee be responsible for access to the safekeeping area where securities are kept. Require that employees who enter and leave the safekeeping area sign and record in a log the exact reason for their access. Require that employees involved in the safekeeping function maintain a subsidiary control ledger for securities on a current basis. Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent.

Require that the safekeeping function for securities be assigned to a bank or stockbroker that will act as a custodial agent.

examples of notes receivable

Sale of industrial machinery, farm equipment Issuance of capital stock Loans to officers, employees

Potential Revenue Recognition Problems

Sales with unusual right to return Side agreements Franchise fees Bill and hold transactions Sales using notes with unusual interest rates Percentage-of-completion method of revenue recognition Multiple element agreements

Internal Control — Cash Disbursements

Segregation of duties Payment by check or electronic funds transfer Pre-numbered check Match of purchase order and receiving documents with vendor's invoice Review of supporting documents by authorized check signer Cancel of supporting documents Authorized check signer should mail checks Monthly bank reconciliation

Revenue Cycle Controls (1 of 2)

Segregation of duties--sales and collections Matching of sales invoices and shipping documents Clerical accuracy checks on invoices Credit approval for sales transactions Mailing of monthly statements Reconciliation of bank accounts Use of control listing of cash receipts Use of budgets and analysis of variances Control over shipping and billing documents Use of authorized credit memoranda Use of chart of accounts and review of account codings

Cooper, CPA, is auditing the financial statements of a small rural municipality. The receivable balances represent residents' delinquent real estate taxes. Internal control at the municipality is weak. To determine the existence of the accounts receivable balances at the balance sheet date, Cooper would most likely: Send positive confirmation requests. Send negative confirmation requests. Examine evidence of subsequent cash receipts. Inspect the internal records, such as copies of the tax invoices that were mailed to the residents.

Send positive confirmation requests.

To determine that all sales have been recorded, the auditors would select a sample of transactions from the: Shipping documents file. Sales journal. Accounts receivable subsidiary ledger. Remittance advices.

Shipping documents file.

To determine that all sales have been recorded, the auditors would select a sample of transactions from the: Shipping documents file. Sales journal. Accounts receivable subsidiary ledger. Remittance advices.

Shipping documents file.

Assess the risks of material misstatement and design tests of controls and substantive procedures that:

Substantiate the existence of receivables and the occurrence of revenue transactions Establish the completeness of receivables and revenue transactions Verify the cutoff of revenue transactions Determine that the client has rights to recorded receivables Establish the proper valuation of receivables and the accuracy of revenue transactions Determine that the presentation and disclosure of receivables and revenue are appropriate

Internal Control over Notes Receivable - subdivision of duties

The custodian of notes receivable should not have access to cash or to the general accounting records The acceptance and renewal of notes be authorized in writing by a responsible official who does not have custody of notes The write-off of defaulted notes be approved in writing by responsible officials and effective procedures adopted for subsequent follow-up of such defaulted notes

Details on Understanding the Client Business

The types of products and services sold. The classes and categories of the client's customers. Whether the business is affected by seasonal or cyclical demand. Typical marketing policies for the client and its industry. Policies regarding pricing, sales returns, discounts, extension of credit, and normal delivery and payment terms. Compensation arrangements that are based on recorded revenue. Typical revenue recognition principles used in the industry and their methods of application.

Which of the following is an example of misappropriation of assets relating to sales? Accidentally recording cash that represents a liability as revenue. Holding the sales journal open to record next year's sales as having occurred in the current year. Intentionally recording cash received from a new debt agreement as revenue. Theft of cash register sales.

Theft of cash register sales.

Objectives for the Audit of Receivables and Revenue

Use the understanding of the client and its environment to consider inherent risk, including fraud risks, related to receivables and revenues. Obtain an understanding of internal control over receivables and revenues. Assess the risks of material misstatement and design tests of controls and substantive procedures that:

The best way to verify the amounts of dividend revenue received during the year is: Recomputation. Verification by reference to dividend record books. Confirmation with dividend-paying companies. Examination of cash disbursements records.

Verification by reference to dividend record books.

Audit Documentation

Working papers - Summary analysis that emphasizes changes during the year under audit - Analyses of additions and retirements for the current year - Analyses of repairs and maintenance expense accounts - Tests of depreciation

Identify the control that is most likely to prevent the concealment of a cash shortage resulting from the improper write-off of a trade account receivable: Write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence. Write-offs must be approved by the accounts receivable department. Write-offs must be authorized by the shipping department. Write-offs must be supported by an aging schedule showing that only receivables overdue by several months have been written off.

Write-offs must be approved by a responsible official after review of credit department recommendations and supporting evidence.

Sources of Notes Receivable

Written promises to pay certain amounts at future dates Notes for substantial amounts Installment note or contract can allow seller to hold lien on goods

examples of test of controls for receivables

a. Examine significant aspects of a sample of sales transactions. b. Compare a sample of shipping documents to related sales invoices. c. Review the use and authorization of credit memoranda. d. Reconcile selected cash register tapes and sales tickets with sales journals. e. Test IT application controls. f. Examine evidence of review and approval of revenue estimates.

Vouch Additions steps for PPE

a. Review changes during the year in construction in progress and examine supporting work orders, both incomplete and closed. b. Trace transfers from the Construction in Progress account to the property accounts, observing propriety of classification. Determine that all completed items have been transferred out of the account. c. On a test basis, vouch purchases of property, plant, and equipment to invoices, deeds, contracts, or other supporting documents. Recompute extensions, footings, and treatment of discounts. Make certain repairs and maintenance expenses were not improperly capitalized. d. Investigate all instances in which the actual cost of acquisitions substantially exceeded authorized amounts. Determine whether such excess expenditures were analyzed and approved by appropriate officials. e Investigate fully any debits to property, plant, and equipment accounts not arising from acquisition of physical assets. f. Determine that the total cost of any plant and equipment assets purchased on the installment plan is reflected in the asset accounts and that the unpaid installments are set up as liabilities.

Assess the risks of material misstatement of cash and design tests of controls and substantive procedures that:

a. Substantiate the existence of recorded cash and occurrence of the related transactions b. Establish the completeness of recorded cash c. Verify the cutoff and accuracy of cash transactions d. Determine that the client has rights to recorded cash e. Determine that the presentation and disclosure of cash, including restricted funds, are appropriate

Assess the risks of material misstatement of financial instruments and design tests of controls and substantive procedures that:

a. Substantiate the existence of recorded financial investments and the occurrence of investment transactions. b. Establish the completeness of financial investments and investment transactions. c. Verify the cutoff of investment transactions. d. Determine that the client has rights to recorded investments.

1. Examples of tests of controls:

a. Test the accounting records and reconciliations by re-performance. b. Compare the details of a sample of cash receipts listings to the cash receipts journal, accounts receivable postings, and authenticated deposit slips. c. Compare the details of a sample of recorded disbursements in the cash payments journal to account payable postings, purchase orders, receiving reports, invoices, and paid checks.

PPE Principle disclosures

a. The basis of valuation should be explicitly stated. At present, cost is the generally accepted basis of valuation for plant and equipment; property not in use should be valued at the lower of cost or estimated realizable value. b. Property pledged to secure loans should be clearly identified. c. Property not in current use should be segregated in the balance sheet.

Examples of tests of controls for financial investments:

a. Trace several transactions for purchases and sales of investments through the accounting system. b. Review and test reports of investment activity prepared for the investment committee. c. Inspect reports by internal auditors regarding their periodic inspection and review of securities and derivative instruments. d. Inspect monthly reports on securities owned, purchased, and sold and amounts of revenue earned and budgeted.

Conditions a. The auditors ordinarily should confirm accounts receivable. b. Accounts receivable are ordinarily confirmed on a standard form developed by the American Institute of Certified Public Accountants and the Financial Executives Institute. c. Confirmations address existence more than they address completeness. d. The confirmation requests should be mailed to respondents by the CPAs. e. Auditors should always confirm the total balances of accounts rather than individual portions (e.g., if the balance is made up of three sales, all three should be confirmed).

a. correct b. incorrect c. correct d. correct e. incorrect

what do you do when you have a type 1 event

adjust financial statement amounts

Significant estimate made by management

allowance for doubtful accounts

Analyze payments subsequent to balance sheet date Document the subsequent payments inspected

analyzing allowance for doubtful accounts

Effective ADAs help to improve

assessments and responses to risks of material misstatement.

Amounts are audited in conjunction with the audit of balance sheet and income statement accounts

audit of statement of cash flows

Main objective of ADAs is to improve

audit quality

When do you peform audit procedures to search for subsequent events?

between balance sheet date and date of the audit report

when are you responsible only for information "coming to auditors' Attention"

between the date of the audit report and report release date

audit procedure using the company's securities during the year and replacing them prior to year-end

comparing the serial numbers of securities on hand to numbers recorded in the prior year's audit working papers

More use of ADAs could result in a more

effective or efficient audit.

Manipulations that utilize temporarily overstated bank balances to conceal cash shortage or meet short-term cash needs

kiting

ADAs are audit procedures used to

ldiscover and analyze patterns, identify anomalies, and obtain other useful information from data populations relevant to the audit

Due to extrapolation from audit evidence or differences in accounting estimates

likely misstatements

most common loss contingency

litigation

Mixture of minor items, some nonrecurring and others received at regular intervals

misc. revenue

- Observations by production supervisors of performance of various activities and functions - Quality and performance reviews - Formal program to consider improvements in purchasing and production noted by internal auditors

monitoring

Properties subject to depletion

natural resources

- ask debtor to advise the auditors only if the balance shown is incorrect Low level of assessed risk of material misstatement Large number of small balances No reason to believe the respondent will ignore the request

negative confirmations

Determine inventory quantities solely by an annual physical count

periodic inventory system

Inventory updated constantly Strong internal control over inventories May use test counts throughout the year

perpetual inventory records (used on valuable inventory)

- request addressed to the debtor asking for a reply Ordinarily sent with balances due on them Blank forms - leave amount blank

positive confirmations

Two methods in which the client makes the formal request:

positive/negative

Audit Procedure for Recording fictitious cash sales throughout the year?

preparing a proof of cash for the entire audit period

audit procedure of kiting of cash?

preparing and verifying a schedule of bank transfers

- Purpose is to have the client's principal officers acknowledge that they are primarily responsible for the fairness of the financial statements - Dated as of the date of the audit report - Not a substitute for application of necessary audit procedures

representation letter

Audit procedure omitting several outstandings checks from the year-end bank reconciliation?

review of the bank statement

Auditors can detect kiting by preparing a what?

schedule of bank transfers for a few days before and after balance sheet date

Best evidence of collectability for allowance for doubtful accounts is what?

subsequent payment

Audit procedure for lapping of accounts receivable?

tracing remittance advices to postings in the accounts receivable records

- Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that a loss has been sustained

true

ADAs can be effectively used in any phase of the audit (i.e., initial planning, risk assessment, assessment of the design and operating effectiveness of controls, substantive procedures and in forming an overall conclusion for the audit).

true