C213 Topic 8: Internal Controls: Ensuring the Integrity of Financial Information

What is the most common professional designation for external auditors?

Certified Public Accountant

External audits are performed by

Certified Public Accountants

Earnings management through deceptive accounting is best exemplified by

Changing the interest rate used in accounting for leases without describing the change in the notes to the financial statements.

Earnings management through aggressive accounting is best exemplified by

Changing the useful life of a depreciable asset and fully disclosing it in the notes

The Public Company Accounting Oversight Board

Conducts inspections of accounting firms

Policies and procedures used by management to meet their objectives.

Control activities or control procedures

Which statement best describes the role of external auditors when auditing a large public company?

D. Examine the organization's accounting for a sample of business transactions to provide reasonable assurance that the financial statements are presented fairly

Which of the following requires CPAs to provide reasonable assurance that significant fraud or misstatement is NOT present in financial statements?

D. Generally Accepted Auditing Standards

If two different accountants were to estimate the percentage of customers who will NOT pay their accounts (bad debts), they could arrive at different estimates. These differing estimates would affect the financial statements. Such differences in assessing estimates are due to

Disagreements in judgment

The Public Company Accounting Oversight Board is NOT required to

Enforce compliance with the Foreign Corrupt Practices Act

Independent CPAs who are retained by organizations to perform audits of financial statements.

External auditors

What is the detailed report that companies file annually with the Securities and Exchange Commission?

Form 10-K

A diagram that represents the flexibility a manager has, within GAAP, to report one earnings number from among many possibilities based on different methods and assumptions.

GAAP oval

The Role of External auditors

Gather evidence to be able to certify the fairness of the financial statements through: • Interviews • Observation • Sampling • Confirmation • Analytical procedures

Using independent reviewers, such as auditors, is an example of which type of accounting procedure?

Independent checks on performance

Financial goals established within a company.

Internal earnings targets

ole of the Securities and Exchange Commission: The SEC adds credibility to financial statements by

Requiring independent audits Reviewing financial statements itself Sanctioning firms that violate its standards

A law passed by Congress in 2002 that gives the SEC significant oversight responsibility and control over companies issuing financial statements and their external auditors.

Sarbanes-Oxley Act

An independent group of experts (in controls, accounting, and operations) who monitor operating results and financial records, evaluate internal controls, assist with increasing the efficiency and effectiveness of operations, and detect fraud.

internal auditors

Policies and procedures established to provide management with reasonable assurance that the objectives of an entity will be achieved.

internal control structure

Lines of authority and responsibility.

organizational structure

Physical precautions used to protect assets and records.

physical safeguards

Internal control activities that are designed to prevent the occurrence of errors and fraud.

preventative controls

Sarbanes-Oxley Act - impacts financial reporting: Constraints on auditors

• Auditors are prohibited from providing nonaudit services to audit clients. • Audit partners must rotate every five years. • Auditors must report to the audit committee of the board of directors.

Techniques of earnings management

• Careful timing of transactions • Changing accounting methods or estimates with full disclosure • Changing accounting methods or estimates withOUT adequate disclosure • Non-GAAP accounting • Fictitious transactions

Sarbanes-Oxley Act- impacts financial reporting: Board (PCAOB)

• Establish auditing standards. • Inspect public accounting firms

The Role of Internal auditors

• Evaluate internal controls • Monitor operating results • Ensure compliance with laws and company policy • Detect fraud

Reasons for earnings management

• Pressure to meet internal earnings targets • Pressure to meet external expectations • Smoothing income • Preparing to apply for a loan or to offer stock to the public

Sarbanes-Oxley Act -impacts financial reporting: Constraints on management

• The CEO and the CFO must personally certify the reliability of the financial statements. • Companies must have a code of ethics. • Loans to company executives are prohibited. • Audit committees must be strengthened.

Which form must be filed quarterly by all publicly held corporations?

10-Q

Which of the following activities would internal auditors NOT typically perform in a large company?

A. Prepare the primary financial statements

Which of the following requires that audit committee members be financially literate?

A. Sarbanes-Oxley Act

Which of the following is NOT one of the effects that the Securities Exchange Act of 1934 had on accountants?

Accountants must audit all 10-Q reports.

If the total amount for Insurance Expense is inadvertently posted to Prepaid Insurance at the end of the year, what will be the effect on the year-end financial statements? A. Expenses will be understated C. Net income will be overstated D. Owner's equity will be overstated

All of these are true

If the total amount for Rent Expense is inadvertently posted to Prepaid Rent at the end of the year, what will be the effect on the year-end financial statements?

Assets will be overstated

According to Sarbanes-Oxley, who are auditors required to report to and be retained by?

Audit committee

Which one of the following errors causes net income to be understated?

B. Failure to record revenue earned but not billed

Which of the following is an example of adequate segregation of duties?

B. Greg is in charge of recording receipt of payments made to accounts receivable, while Susan is in charge of making deposits to the bank.

Which of the following does Sarbanes-Oxley NOT require management to do?

B. Make loans to executive officers and directors

Fraud is

Both the deceptive concealment of transactions and the creation of fictitious transactions

The Sarbanes-Oxley Act establishes A. Independent oversight of auditors B. Constraints on auditors D. Constraints on company management

C. All of these are correct

Which of the following is NOT one of the major safeguards in the financial reporting process?

C. Earnings management

Which of the following is NOT a reason for problems occurring in the financial statements?

C. Safeguards

Recording as an asset expenditures that have no future economic benefit is an example of

Non-GAAP accounting

Board of five full-time members established by the Sarbanes-Oxley Act to oversee the accounting and auditing profession.

Public Company Accounting Oversight Board (PCAOB)

Sarbanes-Oxley Act and how it impacts financial reporting: Public Company Accounting Oversight

Register all public accounting firms.

The government body responsible for regulating the financial reporting practices of most publicly owned corporations in connection with the buying and selling of stocks and bonds.

Securities and Exchange Commission (SEC)

A strategy to provide an internal check on performance through separation of authorization of transactions from custody of related assets, operational responsibilities from record-keeping responsibilities, and custody of assets from accounting personnel.

Segregation of duties

The five types of control procedures are

Segregation of duties Procedures for authorizations Documents and records Physical safeguards Independent checks

Auditing standards developed by the PCAOB for public companies and AICPA for private companies.

generally accepted auditing standards (GAAS)

If an external auditor suspects wrongdoing in financial statements, the concerns should be addressed to

The audit committee

Internal controls are safeguards built into an organization that help to protect assets and increase reliability of the accounting records. The three basic internal control structure categories are

The control environment The accounting systems The control procedures

The practice of carefully timing the recognition of revenues and expenses to even out the amount of reported earnings from one year to the next.

income smoothing

Earnings management through strategic matching is best exemplified by

Timing transactions such that large one-time gains and losses occur in the same quarter.

1. External audits are required of most public companies by the SEC. 2. External audits must be performed by CPAs who are licensed by the individual states in which they practice.

True

When does the Securities and Exchange Commission (SEC) typically require a company to submit a registration statement to the SEC for approval?

When the company issues new debt or stock securities to the public

Procedures for continual internal verification of other controls.

independent checks

Members of a company's board of directors who are responsible for dealing with the external and internal auditors.

audit committee

The actions, policies, and procedures that reflect the overall attitudes of top management about control and its importance to the entity.

control environment

Internal control activities that are designed to detect the occurrence of errors and fraud.

detective controls