ACC 450 Ch. 5

Common- Size Income Statement

All revenues and expenses are expressed as a % of NEW SALES assets, liabilities, and equity are a percentage of total assets

Assertions about ACCOUNT BALANCES

Existence Rights and Obligations Completeness Valuation and allocation not- cutoff and Classification

Confirmations generally are effective at providing evidence about the assertion of __________ but not ___________ or __________ . ex. account receivable confirmation provides reliable evidence about the existence of an obligation but not address...

Existence of accounts Completeness or Valuation ... whether the debtor can actually pay the obligation

RJE affect only the ________ ________ presentation so should not be included in the clients __________ _________ only in the accounting __________

Financial statement accounting records worksheets

Analytical procedures will be on this side for the next 6 cards

Potential misstatements will be on this side for the next 6 cards

6. compare interest expense to average outstanding balance of interest-bearing debt

Understatement of liabilities Misstatement of interest expense

Analysis of a ledger account shows the _________ in an asset, liability, equity, rev, or expense account during period. Most useful for accounts affected by few _______ like plant assets, long term debt.

change transactions

Cross- sectional analysis

compare ratios of similar firms at the same point in time

Two types of material misstatement risk

inherent control

Risk that exists without audit

inherent and control

analytical procedures at the end of audit include

reviewing FS and recomputing ratios to find any undetected or unusual

horizontal analysis

reviewing clients ratios and trends over time

Analytical Example

scanning payroll register for unusual payments

working papers assist auditors responsible for _____________ in reviewing the quality of work

supervision

Test of Controls

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

Who's review is the most technical when reviewing audit papers?

the seniors to see if staff assistants have performed procedures correctly and clearly expressed conclusion

Tests of Details of balances directly address whether... Example

there are misstatements in ending balance of account ex. confirmation of ending balances in AR

When applying valuation techniques a client can choose from 3 levels of inputs (assumptions). What are these called and who do they belong to?

"Fair Value Measurements and Disclosures" - FASB ASC

Level 3

*inputs that are UNOBSERVABLE for the assets or liabilities

Level 2

*quoted prices for SIMILAR assets of liabilities*

Further audit procedures - why are they called that - what are they

- Because their timing, nature, and extent depend on results of risk assessment - Test of Details - Balances, Disclosures, transaction - Analytical Procedurs

Administrative working papers

- audit plans and programs - internal control questionnaires and flowcharts - engagement letter - time budgets - significant discussion with client management

Assertions with high inherent risk

- difficult to audit transactions - complex calculations - difficult accounting issues - significant judgement by management - valuations

Indications of High Inherent risk

- inconsistent profit of client compared to similar firms in industry - going concern problems - operating results that are highly sensitive to economic factors - detections in prior audits - substantive turnover, questionable reputation, inadequate skills

Evidence is more reliable when

- obtained from outside source - generated internally with effective controls - obtained directly by auditor - Documented and original

Reasonableness Test - how is it similar to regression? - how is it different example. hotel

- similar to regression because an explicit expectation is computed using financial and non-financial data - less formal and not based on statistical model ex. average rate * average occupancy rate to find revenue for period

Relevant assertions

- without regard to effect of controls Have a reasonable possibility of containing a misstatement that could cause financial statements to contain material misstatement

When it comes to auditing estimation transactions the AICPA standards require 3 items to be determined by auditor

1. All necessary estimates have been developed 2. They are reasonable 3. properly accounted for and disclosed

Representation Letter from client

1. End of Audit 2. Summarizes the most important oral representations made by management during engagement. - all accounting, financial data, and minutes of directors meetings been made available - FS are complete and conform with GAAP - suggested adj entries not recorded are not material - acknowledges responsibility to design and implement programs and controls to prevents and detect fraud - all items that need to be disclosed have been, properly.

8 other audit procedures?

1. Inspection of Documentation/records 2. Inquiry 3. External Confirmation 4. Inspection of Tangibles 5. Re-performance 6. Re- calculation 7. Observation 8. Analytical procedures

Purpose of Representation Letter 1. Primary 2. others

1. Remind the client officers of their primary and personal responsibilities for the FS 2. to document in working papers the clients responses to the significant questions asked by auditor during engagement - evidence with respect to managements future intentions

3 types of transactions and their inherent risk levels

1. Routine : restricted 2. non- routine : high 3. Estimation : highest!

current file order of docs

1. admin working papers( include FS draft and audit report ) 2. working trial balance, adj, reclassification 3. papers supporting balances

4 categories of working papers

1. audit administrative working papers 2. lead schedules and working trial balance 3. adjusting journal entries and reclassification entries 4. supporting schedules, analysis, reconciliations, and computational working papers 5. corroborating documents

2 things auditors should consider when determining extent of analytical procedures

1. cost benefit 2. effectiveness

Two forms of ratio analysis

1. horizontal 2. cross sectional

working papers assist 3 people

1. internal QC reviewers 2. inspection or peer reviewers 3. future auditors

4 steps to analytical procedure

1. ration/ balance expectation 2. determine acceptable difference 3. Compare company's to expectation 4. Investigate+evaluate significant differences from the expectation

3 purposes of a permanent file

1. refresh auditor memories 2. new staff with summary of policies and organization of client 3. to keep paper on items that show no changes, eliminating necessity to prepare each year

Three ways to evaluate estimations

1. review managements process: reasonableness of steps 2. develop your own process compare results to managers estimate 3. Review the calculations made based on actual events that happen after year end

Audit risk = ____ + ______

1. risk of material misstatement 2. risk of not detecting a misstatement

How many days after report release date do auditors have to complete the audit file? and what is that day called?

60 days Documentation completion date

Most reliable piece of documentary evidence created within client org.? - evidence that an... - 2 items a check bears that indicates review by outsiders

A Paid Check - asset was acquired @ given cost or liability was paid, or expense was incurred. 1. signature of payee 2. stamp indicating payment made by bank

Most efficient test of certain assertions like evaluating the COMPLETENESS of various rev and expense accounts

Analytical substantive procedures

Example of Inquiry

Asking personnel about their operations

why is the working trial balance the backbone to the audit working papers?

Because it is a key schedule that controls and summarizes all supporting papers.

Vertical Analysis is a

Common- Size income Statement

Current files vs Permanent file

Current: solely that years audit papers Permanent: continuing audit interest like articles of incorporation

Substantive Procedures

Designed to detect material misstatement of relevant assurtions

Industry averages available through

Dun & Bradstreet's Key Business Ratios Robert Morris Associate's Annual Statement Studies

Level 1

Inputs of observable prices are of *quoted prices in active markets* for identical asset or liability

2. Compare R&D costs to budget

Misclassification of R&D expenses

5. Compare production records to units to sales

Misstatement of Sales and Inventory

1. Comparison of inventory levels for this year and last

Misstatement of inventory Inventory Obsolescence

4. compare client GP % to industry average

Misstatement of sales and accounts receivable Misstatement of COGS and inventory

3. compare AR turnover for this year to last

Misstatement of sales or AR Misstatement of Allowance for doubtful accounts

Should a representation letter be used as substitute for performing other audit procedures?

NOOOOO! thats what the financial statements do, this just asserts the original representations were correct.

Assertions about Presentations and Disclosures

Occurrence Rights and Obligations Completeness Accuracy and valuation Classification not- cutoff

Assertions about Classes of Transactions

Occurrence completeness accuracy cutoff classification - not rights and obligations

Re-performance Example

Re performing aging of accounts receivable on your own

analytical procedures related to ________ are performed during Risk Assessment stage to identify any unusual relationships involving revenue account.

Revenue

Example of Inspection

Test of controls to inspect records for proper authorization

working papers demonstrate ____________ of audit team for work performed

accountability

What is the backbone of all the audit papers? It is a schedule listing what??

Working trial balance - schedule listing the balances of accounts for current and previous year with columns for auditors proposed adj entries/ reclassifications

Matters that should be in working papers. findings or matters that are significant and action taken to address them, like... 1. selection of appropriate _____________ principles 2. _______/________ transactions 3. issues related to __________ 4. Test __________ indicating misstatement 5. difficulties applying audit __________ 6. finding resulting in Modification _______ 7. identify those who ______ and ______ the work and dates

accounting complex/unusual estimates results procedures report performed and reviewed

Scanning

an analytical procedure using professional judgement to review accounting data and identify significant or items.

Corroborating Documents

articles of incorporation mortgages, audit confirmations, representation letters

A schedule is a listing of elements comprising the ________ of an asset or liability account at a specific ____

balances date

Examples of working papers

bank reconciliation photocopies of minutes of director meetings flowcharts of internal control letters working trial balance

Why is ratio a richer form of analysis than trend analysis

because it examines relationship between two or more variables and may involve industry data.

Representation letters are dated as? are signed by?

date of the auditors report Client CFO AND CEO

risk that exists only if audit happens

detection risk

Reclassification Journal Entries, must be reclassified for _____ presentation. ex. AR with large credit balance should be reclassified as ________.

fair liability

These lead schedules are set up to combine similar _______ ________ _______. The totals appear on the ______ ___________ _______.

general ledger accounts. Working trial balance

Analytical procedures evaluates financial statement info by looking at relationships among _____ and __________ data. simple example

financial and non-financial compare revenue and expense from this year to last and note any significant differences

Lead schedule a.k.a

grouping sheet or summary schedules

Detection risk varies inversely with the risk of....

material misstatement

working papers assist future and current auditors in planning and performing audit. It also serves as a record of

matters of continuing significance for future audits

Disclosure of related party transactions need to have (3 things)

nature of relationship description of transactions terms and manner of settlement

Analytical procedures performed at risk assessment stage of audit are used to determine

nature, timing, and extent of further audit procedures

Risk Assessment Procedures

obtain understand of client environment, internal control, and assess the risks of material misstatement

report release date is the date the client is granted

permission to use the report

Primary measurement of effectiveness of an analytical procedure is ___________. Can be increase by performing a more _______ analytical procedute

precision detailed ex. use monthly data rather than annual

working papers

procedures findings conclusion

Trend/Ratio analysis auditors use __________ __________ to specify an absolute amount of difference that will result in an investigation vs Regression analysis statistical model will identify the items that should be investigated based on degree of ___________ and reliability specified by the ________

profession judgement precision auditor

Appropriate is the measure of the

quality of the audit evidence

Sufficient is a measure of the

quantity of audit evidence that should be obtained

Test of classes of transactions address whether particular...

types of transactions have been properly accounted for

Regression analysis - what is the advantage of using

using statistical models to quantify expectation. - more variables may be used so expectation my be precisely measured

Observation example

watching client count inventory watching mailroom clerks

cold review or quality review is...

when a 2nd partner reviews the audit working papers before signing off CPA firm name.