chpt 5 audit

Reclassification journal entries-

auditors develop for items that although correctly recorded in the accounting records, must be reclassified for fair presentation in the clients financial statements

Inquiries of specialists-

auditors may not be experts in performing such technical tasks as judging the value of highly specialized inventory. This kind of evidence is best from qualified specialists

Industry averages-

available thru sources like Dun & Bradstreet's Key Business ratios and Morris associates annual statement studies

Vertical analysis-

common size balance sheet where all revenues and expenses are presented as a percentage of net sales

Substantive procedures-

designed to detect material misstatements of relevant assertions, include analytical procedures and tests of details of account balances, transactions, and disclosures

Risk assessment procedures (risk matrix)-

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

Tests of controls-

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

Substantive procedures-

helpful to consider their nature (type and form), timing (when performed), and extent (quantity of evidence obtained). procedures performed by the auditor to detect material misstatement in account balances, classes of transactions, and disclosures

Cutoff-

improper classification

Corroborating documents-

include copies of articles of incorporation and bylaws

Differences of opinion-

inconsistencies arise in the working papers because different members of the audit staff reach different conclusions on some complex auditing or accounting issue- all members of the audit team have the right to document in the working papers their disagreement with the decision

• Related party transactions-

individuals or entities that may have dealings with the client in which the other significantly influences one party such that it may not pursue its separate interests. Any transaction between the company and these parties, other than normal compensation arrangements, expense allowances, and similar transactions arising in the ordinary course of business o Not conducted at arms length, so be aware of economic substance of these transactions might differ from their form o Adequately disclosed o Conflict of interest statements

Analytical procedures-

involve evaluations of financial statement information by a study of relationships among financial and nonfinancial data- plausible relationships among data may reasonably be expected to exist and continue in the absence of known conditions to the contrary

Horizontal analysis-

involves a review of client financial statement amounts and ratios over time

Cross sectional analysis-

involves comparisons with similar firms at a point in time, comparing clients ratios to industry averages

Routine transactions-

involves recurring financial statement activities recorded in the accounting records in the normal course of business. Like sales, purchases, cash receipts

Electronic data interchange (EDI)-

involves the transmission of data between organizations by electronic means, more than e-mail ordering in that electronic documents or business data from one company to another often occur without human intervention

Timing of substantive audit procedures-

may be performed before the clients year end or subsequent year end, can go every 3 months

Sufficient-

measure of the quantity of audit evidence that should be obtained

Administrative working papers-

memoranda of the planning process and significant discussions with client management

• Types of working papers

o Audit admistrative working papers o Working trial balance and lead schedules o Adjusting journal entries and reclassification entries o Supporting schedules, analyses, reconciliations, and computational working papers, and corroborating documents

Representation letter-

summarizing the most important oral representations made by management during the engagement

Current files-

the auditors report for a particular year is supported by the working papers contained in this o The administrative working papers usually begin the current files, then followed by the working trial balance and the adjusting and reclassification entities, then it consists of the working papers supporting the balances in the clients financial statements

Report release date-

the date the client is granted permission to use the report o Auditors are given 60 days after it to complete the audit file by assessing a complete and final set of audit documentation o Able to perform routine file assembling procedures like deleting or discarding superseded documentation and sorting final working papers

Inherent risk-

the possibility of material misstatement of an assertion before considering the client's internal control

Audit risk

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

Detection risk-

the risk that the auditor's procedures will not detect a material misstatement that exists in a relevant assertion. Exists because the auditors substantive procedures are not 100% effective o Misstatements detected by the auditors procedures

Audit file-

the working papers for a particular engagement and is the principal record of the work performed during the audit

Adjusting journal entries-

to correct material errors or fraud discovered in the financial statements and accounting records, the auditors draft these

Relevant assertions-

without regard to the effect of controls, have a reasonable possibility of containing a misstatement that could cause the financial statements to be materially misstated

• Guidelines for preparation of working papers o

working paper heading, reviewers initial and date, preparers initial and date, index, tick marks, adjusting entry cross referenced to adjusting entried working paper, explanation of audit work performed, auditors conclusion, cross referenced to accounts receivable lead schedule

o Assertions with high inherent risk:

• Difficult to audit transactions or balances • Complex calculations • Difficult accounting issues • Significant judgment by management • Valuations that vary significantly based on economic factors

Documentation completion date-

After the close of this 60 day period no information may be discarded from audit working papers

• Potential misstatements disclosed by analytical procedures

Comparison of inventory levels for the current year to those of prior years (misstatement of inventory, inventory obsolescence problem) o Comparison of research and development expense to the budgeted amount (misclassification of R&D expenses) o Comparison of accounts receivable turnover for the current year to that of prior years (misstatement of sales or AR, misstatement of the AFDA) o Comparison of the clients gross profit % to published industry averages (misstatement of sales and A/R, COGS and inventory) o Comparison of production records in units to sales (misstatement of sales, inventory) o Comparison of interest expense to the average outstanding balance of interest bearing debt (understatement of liabilities, misstatement of interest expense)

Types of audit procedures

Inspection of records and documents, inquiry of knowledgeable persons, external confirmation, inspection of tangible assets, observation of processes or procedures, recalculation of math accuracy, performance of procedures, analytical procedures

Tests of details- 3 types

Tests of account balances o Tests of classes of transactions o Tests of disclosures

• Permanent file- 3 purposes:

To refresh the auditors memories on items applicable over a period of many years o To provide new staff members with a quick summary of the policies and organization of the client o To preserve working papers on items that show relatively few or no changes, thus eliminating the necessity for their preparation year after year

Working trial balance-

a schedule listing the balances of the accounts in the general ledger for the current and previous year and also providing columns for the auditors proposed adjustments and reclassifications and for the final amounts that will appear in the financial statements o Says who its prepared by, reviewed by, account #, account name, prior period balance, unadjusted trial balance, ref #, adjustments, balance sheet

Financial statement assertions

about accounts , classes, and presentation and disclosure

Nonroutine transactions-

activities that occur only periodically, such as taking of physical inventories, calculating depreciation expense, and adjusting financial statements of foreign currency gains or losses

Audit evidence-

all the information used by the auditors in arriving at the conclusions on which the audit opinion is based

Lead schedules-

also called grouping sheets or summary schedules are set up to combine similar general ledger accounts

Specialist-

an individual or organization possessing expertise in a field other than accounting and auditing. Auditors are responsible for performing procedures to evaluate the adequacy of the professional qualifications and reputation of the specialist

Timing of analytical procedures-

at the risk assessment stage and near the end of the audit. o As risk assessment- analytical procedures are used to assist the auditors in determining the nature, timing, and extent of further audit procedures that will be used to obtain evidence about specific accounts= help auditors identify unusual transactions, events, or amounts that indicate heightened risk of material misstatement of the financial statements

audit procedures

o Inspection of records or documents- examining a record or document o Inquiry- seeking information of knowledgeable persons within or outside the organization o External confirmation- obtaining a written response about a particular item from a third party o Inspection of tangible assets- physically examining an asset o Observation- watching a process or procedure being performed by the entity's personnel or the performance of control activities o Recalculation- testing the mathematical accuracy of documents or records o Performance- an independent execution of procedures or controls that were originally performed by the client o Analytical procedures- evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data o Scanning- use of professional judgment to review accounting data to identify significant unusual items that will be tested

• Audit risk-

o Misstatements undetected by the auditors

Audit evidence is ordinarily more reliable when it is

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

whats on working papers

o Working trial balances, audit plans, correspondence concerning matters, internal control questionnaires, letters or representations obtained by the client and from the clients legal counsel, and returned confirmation forms • Take the form of bank reconciliations or analyses of ledger accounts • Others can have photocopies of minutes of director meetings • Might be organization charts or flow charts of the client's internal control o Audit documentation should be sufficient to allow an experienced auditor understand the audit work performed, evidence obtained, and the conclusions reached

Working papers-

papers that document the evidence gathered by auditors to show the work they have done, the methods and procedures they have followed, and the conclusions they have developed in an audit of financial statements or other type of engagement audit documentation, record of the audit procedures performed, relevant audit evidence obtained, and the conclusions auditors reach. May be recorded on paper or on electronic

Inquiries resulting in lawyers' letters-

primary source of information about litigation that is pending against the client is from these. Auditors ask the client to request their attorneys to furnish directly to the auditors their assessment of any litigation

Nature of analytical procedures-

ratio analysis most common o Develop an expectation of an account or ratio balance o Determine the amount of difference from the expectation that can be accepted without investigation o Compare the company's account ratio balance with the expectation o Investigate and evaluate significant differences from the expectation

AICPA AU-C 580 (PCAOB 333)-

requires auditors to obtain a representation letter on every engagement and provides suggestions as to its form and content o Dated as of the date of the auditors report and signed by both the clients CEO and CFO o Never be used as a substitute for performing other audit procedures

• AICPA AU-C 230 (PCAOB auditing standard #3)

requires that audit documentation provide o Evidence of the auditor's basis for concluding on the achievement of the audit's overall objectives o Evidence that the audit was planned and performed in accordance with GAAS • Working papers are confidential. o AICPA code of professional conduct includes a rule that generally prohibits a member in public practice from disclosing info Audit working papers are the property of the auditors, not the client

Control risk-

risk that a material misstatement could occur in a relevant assertion and not be prevented or detected on a timely basis by the client's internal control Misstatement likely to occur in the clients financial statements, but can be prevented or detected by controls

Parallel simulation-

run info thru clients system to see if its accurate

SALY-

same as last year

Financial statement assertions about accounts

• Existence - assets, liabilities, and equity interest exist • Rights and obligations- the entity holds or controls the rights to assets, and liabilities are the obligations of the entity • Completeness- all assets, liabilities, and equity interests have been recorded • Valuation and allocation- assets, liabilities, and equity interests are included at appropriate amounts

Financial statement assertions about presentation and disclosure

• Occurrence - disclosed events and transactions have occurred • Rights and obligations- disclosed events pertain to the entity • Completeness- all disclosures should have been included • Accuracy and valuation- information is disclosed fairly and at appropriate amounts • Classification and understandability- information is presented and described clearly

Financial statement assertions about classes

• Occurrence- transactions and events that have been recorded have occurred and pertain to the entity • Completeness- all transactions and events have been recorded • Accuracy- amounts and other data relating to recorded transactions have been recorded appropriately • Cutoff- transactions and events have been recorded in the correct accounting period • Classification- transactions and events have been recorded in the proper amounts