Audit Pt. 3

Types of Confirmations (2)

- Positive Confirmations - Negative Confirmations

Concluding Procedures Loss Contingencies (Contingent liabilities)

A contingent liability is a potential future obligation to an outside party for an unknown amount resulting from activities that have already taken place (a potential obligation of unknown amount for an actual event) Overlooked or omitted Example - A lawsuit that has been filed but not yet resolved. FAS 5 (450-20) ◦ Remote ◦ Reasonably Possible ◦ Probable

Management Representation Letter

A letter to the auditors that the client's chief executive and chief financial officers are required to sign that specifies management's responsibility for the financial statements and confirms oral responses given to the auditor during the audit.

*For each misstatement, identify the balance-related audit objective to which it pertains. 1. Several cash receipts were posted to the incorrect customer accounts.

ACCURACY

Concluding procedures Communication with audit committee SAS 99

ALL fraud, irregularities, illegal acts, reportable conditions, other matters (regardless of materiality)

Allowance for Doubtful Accounts (Valuation) (3)

Aging of accounts Bad debt expense analysis Industry comparisons

Accounts Payable Trial Balance

Amount owed to each vendor or for each invoice at a point in time - prepared directly from the AP Master File.

How are bank confirmation differences handled?

Any differences are investigated and resolved.

The results of tests of controls determine whether:

Assessed control risk for sales and cash receipts is okay.

The Payroll Cycle Balance Sheet (3)

Cash Accrued wages, salaries, bonuses & commissions Accrued payroll & withholding

FINANCING CYCLE Debt-Controls Payment of principal & interest (1)

Cash disbursement controls

TOC/STOT -Transaction-Related Audit Objectives Payroll transactions are correctly classified

Classification

FINANCING CYCLE Debt - Substantive Examine board minute approval (3)

Completeness Existence Obligation

Confirmation procedures Mailed by auditor (3)

Consider validity of addresses Maintains control Outside client offices

Testing Controls Over Inventory Rights and Obligations (1)

Consignment - Does client own goods (title)?

Concluding procedures Communication with audit committee SOX

Critical accounting policies & procedures Discussed alternative GAAP considerations Other written communication with management

Cash Controls (5)

Dual Control Encourage customers to take receipts & observe register totals Centralize receipt of cash Cash register and register balancing Point of Sale

FINANCING CYCLE Equity - Substantive Testing Analysis of changes in ______________

Equity/ Equity Rollforward

Substantive Tests of Details Rights & Obligations (4)

Examine vendors statements Confirm accounts payable Review open invoices Contracts/Agreements

What is the primary concern when testing cash?

Existence

Credit Manager (4)

Financial statements Credit reports Approvals Programmed controls—credit limits

Non-recognized Subsequent Events

Formerly known as Type II even Event involving facts coming into existence after balance sheet date Disclose in F/S

Sales Cycle - Risks Remember

Generally the presumption is that there is a risk of material misstatement due to revenue recognition fraud.

FINANCING CYCLE Debt - Substantive Confirm with who?

Holder or prior holder

Substantive Testing of Inventory Presentation and Disclosure (5)

Identify pledged inventory, purchase commitments Method - FIFO, LIFO, Weighted Avg Classification LCM LIFO reserve disclosure

Tests of Controls and STOT

If client has effective internal controls, these tests are used extensively in order to reduce the amount of detail testwork.

Confirmations of A/R required? Certain exceptions apply (must document) (3)

Immaterial Ineffective evidence (low, unreliable response rates) Low risk & effective alternative procedures

Cash - Substantive Why should you obtain a schedule of all transfers between banks for x days prior to and subsequent to reconciliation date (C, CO, Ex)

Kiting

Financial Instruments - Substantive Testing Presentation & Disclosure Level disclosures (FAS 157 - now ASC 820) 3 levels?

Level 1 - Prices in an active market for identical assets Level 2 - Observable inputs other than quoted prices Level 3 - Use of unobservable inputs such as a pricing model or discounted cash flow

Sales/Cash Receipts/AR controls are generally effective because:

Management is concerned with keeping accurate records & maintaining good client relationships

FINANCING CYCLE Debt-Controls Authorization of debt (2)

Minutes to the board of directors meetings Two officer signatures

Completeness - anything ___________?

Missing

Sales Cycle - Analytical Procedures Analytical Procedure: Compare individual customer balances over a stated amount with previous years Possible Misstatement: ?

Misstatements in accounts receivable and related income statement accounts

*For each audit procedure, identify the balance-related audit objective(s) it partially or fully satisfies. 3. Compute accounts receivable turnover for the current year and compare to the prior year

NET REALIZABLE VALUE & EXISTENCE

Loss Contingencies Remote

No disclosure in F/S

TOC/STOT -Transaction-Related Audit Objectives Recorded payroll payments are for work actually performed by existing employees

Occurrence

Confirmation procedures Prepared by Client (2)

On client letterhead Signed by client (approves release of information)

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? Also, don't forget to

Open boxes, etc - professional skepticism

Sales Orders - Controls

Passwords/User IDs Validity test Customer authorization Prenumbered (independent testing)

Confirmation Procedures (4)

Prepared by client Mailed by auditor Returned by customer directly to auditor's offices Mail second & third requests

FINANCING CYCLE Debt - Substantive Collateral (1)

Presentation & disclosure

Testing Controls Over Inventory Completeness (Understatement) (1)

Process to record materials freight-in, taxes, labor, and overhead

Accounts typically associated with acquisition and payment cycle transactions (3)

Propery, plant, and equipment Prepaid expenses Accrued liabilities

Flow of Inventory Costs (6)

Purchasing Receiving Store Raw Materials WIP Store Finished Goods Shipping

FINANCING CYCLE Debt-Controls Documentation & records (2)

Safeguarded Appropriate accounting considerations

Summarize Confirmation Results Number and $ Amount (5)

Sent Returned Returned/confirmed Returned with exception Not returned

Payroll - Controls (5)

Separate Personnel - S.O.D. Review human resource policies Examine employee files Examine payroll records for indication of approval Examine reviewed summary reports

Concluding procedures Communication with audit committee SAS 115

Significant deficiencies & material weaknesses (communicate in writing)

Payroll Cycle - Overview Can you think of when this cycle becomes complicated and is tested extensively?

Stock compensation and complex bonus/commission arrangements

TOC/STOT -Transaction-Related Audit Objectives Payroll transactions are recorded on the correct dates

Timing

Control Testing Design Substantive Tests of Transactions for Sales:

Usually correspond with the transaction-related audit objectives and help the auditor determine whether monetary misstatements exist in sales transactions

FINANCING CYCLE Debt - Substantive Foot and Extend

Valuation & allocation/completeness

Integration of Tests Tests of the Acquisition and Payment Cycle

When auditors verify inventory acquisitions as part of this cycle, they are also obtaining evidence about the accuracy of raw materials acquired and manufacturing costs incurred (except labor)

Kiting

cash is created using the lag between the time a check is deposited and the time it clears the bank

In-Class Practice Exercise: For each procedure listed below, identify the balance related audit objective. 2. Examine supporting documents for cash disbursements several days before and after year-end.

*COMPLETENESS & CUT-OFF*

Key Controls & Requirements - Physical Inventory Count Auditing standards require that auditors satisfy themselves about the effectiveness of the client's methods of counting inventory and the reliance they can place on the client's representations about the quantities and physical condition of the inventories. To meet this requirement the auditors must perform the following 4 activities:

1. Be present at the time the client counts the inventory 2. Observe the client's counting procedures 3. Make inquiries of client personnel about their counting procedures 4. Make their own independent tests of the physical count

Tests of Controls and STOT are divided into 2 areas:

1. Tests of acquisitions - processing purchase orders, receiving goods and services and recognizing the liability 2. Tests of payments - processing and recording of cash disbursements

Internal Controls Over Cash Receipts

1. separate duties when receiving cash 2. use cash short and cash over the counter 3. prepare a monthly bank reconciliation

Polling Question: What is an appropriate audit response if the client's internal controls for recording sales returns and allowances is evaluated as ineffective? A. All sales returns must be confirmed with the customer B. A larger sample may be needed to verify cutoff C. All sales returns must be traced to supporting documentation D. Sampling is not appropriate

B. A larger sample may be needed to verify cutoff

Sales and Collection Cycle Update/Record what?

Bad debt expense

FINANCING CYCLE Debt - Substantive Examine notes payable agreements (3)

Compare agreement amount to GL amount (existence) Examine for terms, deed, pledging, restrictions, compensating balances, etc. (obligation, completeness, presentation & disclosure) Consider appropriate accounting treatment (valuation/allocation)

Substantive Tests of Details Existence/Occurrence (3)

Confirm unusual balances - confirmations not required Examine supporting docs Look for improper or non-business transactions

Substantive Testing of Inventory Completeness (FLOOR TO RECORDS) (3)

Materials freight-in, taxes, labor, and overhead must be recorded as product costs In conjunction with the inventory observation, auditor should test the physical inventory report by tracing a sample of pre-numbered inventory tags to the physical inventory report sheets. Special consideration of consigned inventory or pledged inventory

Auditors then use the results of the substantive tests of transactions to determine extent to which ______ is satisfied for each objective - and then design and perform _________

PDR AP & Detail Tests

Receiving Report

Paper or electronic document prepared at the time goods are received. Includes a description of the goods, the quantity received, the date received and any other relevant data (Note: receipt of goods is a critical point in the cycle because it is when most companies first recognize the acquisition and related liability)

Audit Perspective - Sales and Cash Cycles (4)

Planning - Assess materiality and inherent risk Understand Controls - Assess control risk Possibly Test Controls to Support Based on Above - Design and test (Substantive testing)

The Acquisition and Payment Cycle Income Statement (3)

Purchases (Cost of Goods Sold) Purchase returns & discounts All expenses (except payroll)

Refusal by a client to sign a management rep letter would require the auditor to issue what type of opinion?

Qualified or Disclaimer

Are receipt of bank confirmations required?

Receipt of bank confirmations are not required; however, auditors usually obtain a direct receipt of a confirmation from every bank or other financial institutions

Payroll - Tests of Details of Balances What is the primary concern?

UNDERSTATEMENT - auditors test to ensure that there are no understated or omitted accruals - looks at subsequent disbursements

Shipping - Controls (4)

Use numerical shipping documents Account for pre-numbered documents Shipping documents provide evidence of title transfer Separate from other Sales & A/R duties

In-Class Practice Exercise: For each procedure listed below, identify the balance related audit objective. 4. Review the general ledger trial balance and supporting documentation to determine whether accounts payable, related parties and other related assets and liabilities are properly included on the financial statements.

*CLASSIFICATION*

Sales Cycle - Risks Common types of sales related fraud: (7)

1. Premature recognition 2. Fictitious sales 3. Failure to record sales returns 4. Side Agreements 5. Keeping the books open past the period close 6. Channel Stuffing (example of Bristol Myers Squibb) 7. Manipulating receivable balance (overstating A/R by understating the allowance)

Key Controls & Requirements - Physical Inventory Count Client's key controls should be:

1. Proper Instructions 2. Supervision by responsible personnel 3. Independent internal verification of the counts 4. Independent reconciliations of the physical counts with perpetual inventory master files 5. Adequate control over count sheets or tags

Audit Procedure: For 20 nontangible acquisitions, select a sample of line items from the acquisition journal and trace each to related vendors' invoices. Examine whether each transaction appears to be a legitimate expenditure for the client and that each was approved and recorded at the correct amount and date in the journal and charged to the correct account per the chart of accounts. A. Type of Evidence B. Type of Test C. Audit Objective

A. Inspection of external documentation B. Test of control and Substantive test of transactions C. Occurrence, Accuracy, Timing, Classification

Audit Procedure: Examine a sample of receiving report numbers and determine whether each one has an initial indicating that it was recorded as A/P. A. Type of Evidence B. Type of Test C. Audit Objective

A. Inspection of internal documentation B. Test of control C. Completeness

Audit Procedure: Select a sample of equipment listed on the fixed asset master files and inspect the asset to determine that it exists and to determine its condition. A. Type of Evidence B. Type of Test C. Audit Objective

A. Physical examination B. Test of details of balances C. Existence, Realizable value

Transaction-Related Audit Objectives Existence/Occurrence

A/R exists, Sales Occurred ◦ Auditor concerned with 3 types of misstatements - 1) Sales booked but no shipment occurred, 2) Sales recorded more than once, 3) Shipments made to nonexistent customers and recorded as sales

Cutoff Sales returns for subsequent period

Accounting standards require sales returns to be matched with related sales if the amounts are material (current period shipments are returned in the subsequent period then the sales return should appear in the current period). But most companies record returns in the accounting period in which they occur and may even establish a reserve for returns.

TOC/STOT -Transaction-Related Audit Objectives Recorded payroll transactions are for the amount of time actually worked and are at the proper pay rates; withholdings are correctly calculated

Accuracy

Payroll - Tests of Details of Balances ACCRUED PAYROLL EXPENSES - what are the two major balance-related audit objectives in testing payroll liabilities? (2)

Accuracy - Accruals in the trial balance are stated at the correct amounts Cutoff/Completeness - Transactions are recorded in the proper period

Financial Instruments - Substantive Testing Presentation & Disclosure

Accurate presentation on the face of the financials; policy for investments disclosed Level disclosures (FAS 157 - now ASC 820) Level 1 - Prices in an active market for identical assets Level 2 - Observable inputs other than quoted prices Level 3 - Use of unobservable inputs such as a pricing model or discounted cash flow

Prepaid Expenses (Assets) Controls (3)

Acquisition & Payment Cycle (primarily controls over cash disbursements) Authorization Independent verification

What do auditors do after receiving the completed bank confirmation?

After auditors receive the completed bank confirmation, the confirmed balance should be traced to the amount stated on the bank reconciliation.

*For each misstatement, identify the balance-related audit objective to which it pertains. 7. Goods were returned for credit on the last day of the fiscal year but the sales return was not recorded until the following fiscal year.

CUT-OFF

The Acquisition and Payment Cycle Balance Sheet (5)

Cash Inventory Property, Plant, & Equipment Prepaid Expenses Accounts Payable *every transaction usually hits accounts payable

Sales Cycle - Analytical Procedures Note:

Comparisons are usually made to prior year(s) but may also include comparisons to industry data and/or budgets

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) A/R subsidiary ledger and revenue journal ties to G/L

Completeness

Payroll - Controls What are generally considered to be the most significant risks associated with the payroll cycle? (2)

Creation of fictitious employees Falsification of hours worked

Sales and Collection Cycle Before goods are shipped a properly authorized person must approve what?

Credit

Billing - Controls (7)

Every shipped product should be billed ◦ Tie into sequentially numbered shipping docs Sales invoices created by computer ◦ Assigned sequential numbers ◦ Accuracy checked by computer ◦ Match shipping documents with sales orders & purchase orders (customer PO's) System verifies pricing & discounts System produces monthly statements (accuracy checked by computer) Passwords/User IDs Input validation controls Batch controls (semi-manual system)

Substantive Tests of Details Accuracy (3)

Examine and compare voucher packets for amounts Confirm balances Confirm purchase discounts & advertising credits

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? SAMPLE SIZE

Focus is on observing procedures rather than selecting items for testing. How good are controls???

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? Sample Size

Focus is on observing procedures rather than selecting items for testing. How good are controls???

Financial Instruments — Substantive Testing Detail Tie-In

Foot schedule and prove activity Trace to general ledger

Audit of Cash Balances Types of Cash Accounts: Branch accounts

For companies operating in multiple locations, it is often desirable to have a separate bank balance at each location.

Control Testing Design Tests of Controls for Sales Cycle:

For each key control, one or more tests of controls must be designed to verify its effectiveness

Financial Instruments — Substantive Testing Existence/Occurrence

Inspect securities Confirm (rights) - brokers, banks, etc. Examine supporting docs

FINANCING CYCLE Debt-Controls Independent periodic verification (2)

Internal audit or high level person Compliance with debt covenants

Payroll and Inventory Need to test __________ over ____________ - such as reviewing job tickets or tracing other evidence of an employee having worked on a job or process to the accounting records.

Internal controls Proper classification

FINANCING CYCLE Debt - Substantive Examine paid checks for debits to ___________

Notes Payable representing payments

Payroll - Substantive Testing Completeness (3)

Numerical sequence of time cards, checks, etc. to GL Reconcile disbursements in the payroll journal to disbursements on the payroll bank statement Payroll account bank reconciliation

Payroll Cycle - Service Organizations If a client uses a service organization for payroll, how do auditors get comfortable and test payroll controls?

OBTAIN A TYPE 2 SOC I (SSAE 16) --- formerly known as SAS 70 reports

Testing Controls Over Inventory Existence/Occurrence (Overstatement) (2)

Observe separation of duties Observe inventory counts - periodic ◦ Does the client have proper instructions? Adequate supervision? Independent verification procedures? Independent recs of the physical counts with perpetual inventory records? ◦ Auditor needs to understand the client's physical inventory count controls BEFORE the inventory observation begins.

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? Selection - Auditors should be careful to: (3)

Observe the counting of the most significant items and have a representative sample of typical inventory items Inquire about items that are likely to be obsolete or damaged Discuss with management the reasons for excluding any material items

Explain the objective of each audit procedure. 23-20 (Objective 23-3) You are auditing general cash for the Pittsburgh Supply Company for the fiscal year ended July 31, 2019. The client has not prepared the July 31 bank reconciliation. After a brief discussion with the owner, you agree to prepare the reconciliation, with assistance from one of Pittsburgh Supply's clerks. You obtain the following information: General Ledger Bank Statement Beginning balance 7/1/19 $ 6,400 $ 8,378 Deposits (BS) 25,474 Cash receipts journal (GL) 26,874 Checks cleared (BS) (25,307) Cash disbursements journal (GL) (23,171) July bank service charge (BS) (135) Note paid directly (BS) (5,200) NSF check (BS) (412) Ending balance 7/31/19 $ 10,103 $ 2,798 June 30 Bank Reconciliation Information in General Ledger and Bank Statement Balance per bank $8,378 Deposits in transit 600 Outstanding checks 2,578 Balance per books $6,400 Additional information obtained is as follows: 1. Checks clearing that were outstanding on June 30 totaled $2,411. 2. Checks clearing that were recorded in the July disbursements journal totaled $21,120. 3. Deposits included $600 from June and $24,874 for July. 4. A check for $1,130 cleared the bank but had not been recorded in the cash disbursements journal. It was for an acquisition of inventory. Pittsburgh Supply uses the periodic-inventory method. 5. A check for $646 was charged to Pittsburgh Supply but had been written on a different company's bank account. 6. The bank charged Pittsburgh Supply's account for a nonsufficient funds check totaling $412. The credit manager concluded that the customer intentionally closed its account and the owner left the city. The check was turned over to a collection agency. 7. A note for $5,000, plus interest, was paid directly to the bank under an agreement signed four months ago. The note payable was recorded at $5,000 on Pittsburgh Supply's books. Required a. Prepare a bank reconciliation that shows both the unadjusted and adjusted balance per books. b. Prepare all adjusting entries. c. What audit procedures would you use to verify each item in the bank reconciliation? d. What is the cash balance that should appear on the July 31, 2019, financial statements?

OUTSTANDING CHECKS CALCULATION 6/30 Outstanding Checks Balance 2,578 July checks per the books 23,171 July checks per the bank** (25,307) Erroneous check charge 646 Unrecorded check 1,130 7/31 Outstanding Checks Balance 2,218 DEPOSIT IN TRANSIT CALCULATION 6/30 DIT Balance 600 July deposits per the books 26,874 July deposits per the bank (25,474) 7/31 DIT Balance 2,000 BALANCE PER BANK: Add DIT, Subtract OS and anything else missed by bank? Balance Per Bank: 2,798 Add: Deposits in Transit 2,000 Checks erroneously charged to company 646 Less: Outstanding Checks (2,218) Adjusted Bank Balance: 3,226 BALANCE PER BOOKS: What adjustments need to occur? (Hint: consider items 6, 7 and bank service charge) Balance Per Books (before AJE's): 10,103 Adjustments: July Bank Service Charge: (135) Note Payment: (5,200) NSF Check: (412) Unrecorded Check: (1,130) Adjusted Balance per Books: 3,226

Property, Plant, & Equipment - Substantive Testing (3)

Obtain Schedule (Fixed Asset Master File) from Client Test Beginning Balance (Existence) Test Additions (Existence, Valuation, Rights, Cut-off)

Proper authorization/approval usually is focused on:

Occurrence/existence

Cost Accounting Physical controls

Organization (Separate secured (locked) storage areas)

Payroll Cycle - Service Organizations Payroll is often _________ to a service organization - such as ADP.

Outsourced

Sales Cycle - Risks Risk is

Overstatement

Sales Cycle - Analytical Procedures Analytical Procedure: Compare sales by month (by product line) over time Possible Misstatement: ?

Overstatement or Understatement of sales and accounts receivable

Sales Cycle - Analytical Procedures Analytical Procedure: Compare aging categories as a percentage of accounts receivable with previous years Possible Misstatement: ?

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense

Sales Cycle - Analytical Procedures Analytical Procedure: Compare allowance for uncollectible accounts as a percentage of accounts receivable with previous years Possible Misstatement: ?

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense

Sales Cycle - Analytical Procedures Analytical Procedure: Compare write-off of uncollectible accounts as a percentage of total accounts receivable with previous years Possible Misstatement: ?

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense

Sales Cycle - Analytical Procedures Analytical Procedure: Compare number of days that accounts receivable are outstanding with previous years and related turnover of accounts receivable Possible Misstatement: ?

Overstatement or understatement of allowance for uncollectible accounts and bad debt expense; also may indicate fictitious accounts receivable

Sales Cycle - Analytical Procedures Analytical Procedure: Compare gross margin percentage with previous years (by product line) Possible Misstatement: ?

Overstatement or understatement of sales and accounts receivable

Movement Through the Cycle - Controls Issuing (raw materials store) (4)

Pre-numbered requisition to manufacturing An example of an effective control is the use of approved materials requisitions (that are sequentially numbered) to obtain raw materials from the storeroom Based on bill of materials Authorization

FINANCING CYCLE Debt - Substantive Related party debt (1)

Presentation & disclosure

FINANCING CYCLE Debt - Substantive Subsequent pay-off of notes (1)

Presentation & disclosure

Substantive Testing of Inventory Valuation/Allocation (5)

Price Testing (sample and determine if properly valued) Test the mathematical accuracy of the inventory report and reconcile it to the general ledger inventory accounts Analysis of overhead allocation, budgets, variances, etc. Lower of cost or market (LCM)/obsolete? Other analytical procedures-gross margin analysis, inventory turnover, non- financial info

In Summary.... The results of tests of controls and substantive testing for the sales cycle affect the ________, ___________, __________, and ____________ (remember: effective controls will result in reduced detail testing when compared against companies with ineffective controls) _________ are designed to determine the reasonableness of balances in sales, A/R, and other accounts affected by this cycle. Examples of _________ include A/R confirmation and examining documents supporting the balance in these accounts.

Procedures Sample size Timing Items selected for detail testing Detail tests Detail tests

Many confirmations add a ___________ to the bottom of the letter asking about side agreements

Request

Sales Cycle-Substantive Tests Volume of substantive procedures varies with what? (2)

Risk assessments Internal controls

FINANCING CYCLE Equity - Substantive Testing R/E testing (2)

Roll forward Dividends

Property, Plant, & Equipment - Substantive Testing Test dispositions (completeness) (4)

Search for unrecorded Gains or losses on sales What happens if client fails to record asset disposal? ◦ NBV is overstated until the asset is fully depreciated The following procedures are often used to verify disposals: ◦ Review whether newly acquired assets replace existing assets ◦ Analyze gains and losses on the disposal of assets ◦ Make inquiries of plant personnel

Payment/Cash Disbursement - Controls (5)

Separate duties - Check signer independent from accounts payable (Custody vs. Recording) Check signer should carefully review voucher packet(s) Dual signatures Checks should be sequential and check stock locked up Bank reconciliation

FINANCING CYCLE Equity - Controls Authorization - in board minutes (3)

Shares authorized, issued, par, options, warrants, etc. Repurchase of treasury stock Dividends declared

Payroll - Substantive Testing Rights and Obligations (2)

Trace to authorization of bonuses, pay raises, etc. Re-compute obligation — payables

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Collectability

Valuation - Net

Integration of Tests Tests of Payroll and Personnel Cycle

Verification of labor costs

Example from Text of Process Mining Through Audit Data Analytics (Pg. 463)

"Audit data analytics can be used to map the flow of transactions through an accounting system in order to obtain an understanding of the business process and related internal controls surrounding the process. Understanding the normal flow allows an auditor to identify individual transactions or groups of transactions that follow an unusual path. The AICPA Guide to Audit Data Analytics provides an example of this technique, referred to as process mining, as applied to sales transactions. An auditor can use the transaction log generated within an entity's ERP system to trace sales transactions through the system, providing evidence relevant to assessing the risks of material misstatement surrounding occurrence, completeness, accuracy and cutoff of revenue. The transaction log identifies relevant information such as who originated the transaction, when it was performed, and the nature of the transaction. For example, a normal sales transaction may originate with a sales order, include an indication of approval of sales terms, include a shipping document, and end with a sales invoice and the recording of the sales transaction. Using the ERP transaction log, an auditor can identify all transactions that do not follow the normal path. For example, an auditor may identify sales transactions that did not originate with a sales order, or sales invoices that are not supported by a shipping document, or orders without proper approval. These non-standard transactions, or "variant process" paths, may be indicative of higher risk of material misstatement or may be explained by other processes that can be tested separately by the auditor (e.g. rush orders may follow an alternative path with additional controls). As with other ADA used as a risk assessment procedure, the auditor needs to document the purpose of the procedure as well as the findings and conclusions related to assessed risks of material misstatement."

JRR Company has $112,000 in an accrued payroll account. The company's weekly payroll is $186,700 and the accrual represents 3 out of 5 working days. As the auditor, you have determined that payroll controls are effective; therefore, what additional work should you do to test the accrued payroll balance?

$186,700 * 3/5 = $112,020. Since our expectation for the accrual very closely approximates the actual accrual, no further test work is considered necessary.

In-Class Practice Exercise: For each procedure listed below, identify the balance related audit objective. 3. For liabilities that are payable in an fx, determine the exchange rate and check calculations.

*ACCURACY*

In-Class Practice Exercise: For each procedure listed below, identify the balance related audit objective. 1. Obtain a list of accounts payable. Re-foot & compare with the general ledger.

*DETAIL TIE-IN*

In-Class Practice Exercise: For each procedure listed below, identify the balance related audit objective. 5. Vouch a sample of entries in the accounts payable master file to supporting documents.

*EXISTENCE*

RECAP: Key Controls & Requirements - Physical Inventory Count Auditing standards require that auditors satisfy themselves about the effectiveness of the client's methods of counting inventory and the reliance they can place on the client's representations about the quantities and physical condition of the inventories. To meet this requirement the auditors must perform the following 4 activities:

1. Be present at the time the client counts the inventory 2. Observe the client's counting procedures 3. Make inquiries of client personnel about their counting procedures 4. Make their own independent tests of the physical count

Auditors are concerned with the following 3 aspects of internal controls for this cycle:

1. Controls that prevent or detect embezzlement 2. Controls over cutoff 3. Controls related to the allowance for doubtful accounts

Bank reconciliations are very good at catching timing differences Examples include: (3)

1. Failure to include a check that has not cleared the bank on the outstanding checklist, even though it has been recorded on the cash disbursement journal 2. Cash received by the client subsequent to the balance sheet date, but recorded as cash receipts in the current year 3. Payments on notes debited directly to the bank balance by the bank but not entered in the client's records

RECAP: Key Controls & Requirements - Physical Inventory Count Client's key controls should be: (5)

1. Proper Instructions 2. Supervision by responsible personnel 3. Independent internal verification of the counts 4. Independent reconciliations of the physical counts with perpetual inventory master files 5. Adequate control over count sheets or tags

Allowance for Doubtful Accounts (Valuation) Aging of accounts (4)

90+ day status % of each column to total Discussions with management and collections/credit department Confirmations

Audit Procedure: Calculate the ratio of equipment repairs and maintenance to total equipment and compare with previous years. A. Type of Evidence B. Type of Test C. Audit Objective

A. Analytical procedure B. Analytical procedure C. Existence, Completeness, Accuracy

Audit Procedure: Review the acquisitions journal for large and unusual transactions. A. Type of Evidence B. Type of Test C. Audit Objective

A. Analytical procedure B. Analytical procedure C. Occurrence, Accuracy, Classification

Audit Procedure: Send letters to several vendors, including a few for which the recorded accounts payable balance is zero, requesting them to inform us of their balance due from Cooley. Ask the controller to sign the letter. A. Type of Evidence B. Type of Test C. Audit Objective

A. Confirmation B. Test of details of balances C. Existence, Completeness, Accuracy, Cutoff

Audit Procedure: Obtain from the client a written statement that all mortgages payable have been included in the current year financial statements and have been accurately recorded and that the collateral for each is included in the footnotes. A. Type of Evidence B. Type of Test C. Audit Objective

A. Inquiry of client B. Test of details of balances C. Completeness, Accuracy

Audit Procedure: Examine invoices and related shipping documents included in the client's unpaid invoice file at the audit report date to determine whether they were recorded in the appropriate accounting period and at the correct amounts. A. Type of Evidence B. Type of Test C. Audit Objective

A. Inspection of external documentation B. Test of details of balances C. Completeness, Cutoff, Accuracy

Audit Procedure: Select a sample of cancelled checks and trace each one to the cash disbursements journal, comparing the name, date and amount. A. Type of Evidence B. Type of Test C. Audit Objective

A. Inspection of external documentation (cancelled checks) B. Substantive test of transactions C. Completeness, Timing, Accuracy

Audit Procedure: When the check signer's assistant writes "paid" on supporting documents, watch whether she does it after the documents are reviewed and the checks are signed. A. Type of Evidence B. Type of Test C. Audit Objective

A. Observation B. Test of control C. Occurrence

Audit Procedure: Refoot the acquisitions journal for one month and trace all totals to the general ledger. A. Type of Evidence B. Type of Test C. Audit Objective

A. Recalculation B. Substantive test of transactions C. Posting and summarization

Audit Procedure: Recalculate the portion of insurance premiums on the client's prepaid insurance schedule that is applicable to future periods. A. Type of Evidence B. Type of Test C. Audit Objective

A. Recalculation B. Test of details of balances C. Accuracy

Polling Question #3: The bank reconciliation... A. Should be performed by someone independent of the handling or recording of cash receipts. B. Ensures that no cash has been embezzled. C. Must be done on a daily basis if the client uses electronic banking. D. All of the above.

A. Should be performed by someone independent of the handling or recording of cash receipts.

Adapted From Discussion Question 14-25 Business A - STARBUCKS. Customers use cash, debit cards, credit cards or pre-paid Starbucks cards to purchase drinks that are served within minutes. Business B - AMAZON. Huge selection of products purchased through on-line site. Business C - PHYSICIAN. Examines patients and prescribes treatment/medicine as needed. Insured patients pay with co-pay and balance paid by insurance company Business D - UNIVERSITY. Significant portion of revenue from tuition. Bill students in advance for upcoming term. 1) What documents or other source evidence would you use to test the occurrence transaction-related audit objective for sales for each of the following businesses:

A. Starbucks - Reconcile sales records generated by the cash register system to cash recorded by the bank. Perform AP on the relationship between sales recorded and inventory usages. B. Amazon - Inspect documentation from distribution centers that goods were shipped for a selection of sales transactions. C. Physician - Inspect documentation of medical procedures performed in the patient's medical records for a sample of patient rev transactions. D. University - Verify student payments for a selection or verify registrar's records that student is enrolled and course grades issued.

Control Testing Determining extent of control testing:

After identifying key internal controls and control deficiencies, the auditor assesses control risk (control testing must be performed for accelerated & large accelerated filers - done for other companies if control risk is assessed below the maximum)

Loss Contingencies Commitments - Examples? (Agreement to commit the firm to a set of fixed conditions in the future)

Agreements to purchase materials Lease facilities at a certain price Royalty Agreements Bonus plans/profit sharing

Acquisitions Journal

Aka Purchases Journal, generated from the acquisitions transactions file and typically includes the vendor name, date, amount and account classifications for each transaction.

Confirmation by Sampling Subject ____ accounts to sample ______ customers—confirm large % Select _____________ & stratify remaining population - usually some type of stratification is desirable Focus on ____ accounts Be aware that management may ______________ the auditor to send confirmation requests to certain customers. Auditor MUST inquire about the reason and obtain evidence to evaluate the reasonableness of this request (any indication of fraud risk or increased RMM?)

All Few Significant balances Old Refuse to allow

Cash Controls Controls should provide assurance that: (3)

All cash that should be received was actually: ◦ Received ◦ Recorded ◦ Promptly Deposited (not by accounting) Cash disbursements were made for authorized purposes & recorded Cash balances are maintained at adequate, not excessive levels (budgets/forecasts)

What should information on the reconciliation be traced to?

All information on the reconciliation should be traced to the relevant audit schedules.

Accumulated Depreciation - Substantive Testing Test Depreciation Expense (Accuracy & Valuation) (4)

Analytic review Overall computation Detail computation Appropriate life & method- Auditor should consider: ◦ Useful life ◦ Depreciation Method ◦ Estimated Salvage Value ◦ Depreciation policy for year of acquisition & disposition

Remember from previous classes that the auditor considers many things before designing detail tests - such as,

Assessed risk and results of other testwork.

Inquiry of Attorneys Attorney responsibility

Attorneys required to respond. If attorney refuses to provide the auditor with information about material existing lawsuits (asserted claims) or unasserted claims, auditors must modify their audit report to reflect the lack of available evidence ---- SCOPE LIMITATION ---- WHICH TYPE OF OPINION? QUALIFIED OR DISCLAIMER

Subsequent Discovery of Facts

Auditor discovery that the financial statements are materially misstated, or that the opinion on internal controls over financial reporting may not have been appropriate, after they have been issued

Integration of Tests Tests of Cost Accounting

Auditors test physical controls, transfers of raw material costs to WIP, transfers of costs of completed goods to finished goods, perpetual inventory master files and unit cost records.

Financial Instruments — Controls Separation of duties (3)

Authorizing purchases & sales Custody of certificates Recording of transactions

Sales Cycle - Analytical Procedures Test interrelationships between what?

B/S & I/S accounts

Remember - a well-prepared, independent _______________ is an essential control over cash.

Bank Reconciliation

Obtain listing of ______________ opened or closed during year for permanent file

Bank accounts

FINANCING CYCLE Debt - Substantive Trace cash received from issuance of note or bonds to where?

Bank statement recording incoming cash

Sales and Collection Cycle Customers are ________ for goods/services

Billed

Types of Confirmation Positive (2)

Blank With amount

*For each misstatement, identify the balance-related audit objective to which it pertains. 8. Long-term interest bearing notes receivable from affiliated companies are included in AR.

CLASSIFICATION

*For each misstatement, identify the balance-related audit objective to which it pertains. 2. Several accounts receivable in the AR master file are not included in the aged trial balance.

COMPLETENESS

*For each misstatement, identify the balance-related audit objective to which it pertains. 4. A shipment made in the subsequent period is recorded as a current period sale.

CUT-OFF

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? TIMING

Can physical count be taken before year-end (based on accuracy of perpetual inventory master files). Must have effective internal controls to observe inventory at an interim date. Must coordinate with client.

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? Timing

Can physical count be taken before year-end (based on accuracy of perpetual inventory master files). Must have effective internal controls to observe inventory at an interim date. Must coordinate with client.

The Financing cycle Balance Sheet (9)

Cash Notes, Contracts, Mortgages, Bonds Payable Accrued Interest Payable Dividends Payable Capital Stock (Common & Preferred) Treasury Stock Paid-in Capital Retained Earnings (including Dividends) OCI

Sales and Collection Cycle Balance Sheet (4)

Cash Trade accounts receivable Allowance for uncollectible accounts Deferred revenue

Where are cash confirmations received?

Cash confirmations are now received almost exclusively via the site: www.confirmation.com

Sales and Collection Cycle Process/Record what?

Cash receipts Sales returns and allowances

Testing Controls Over Inventory Presentation & Disclosure (2)

Classification (raw materials, WIP, finished goods) Disclosure of purchase commitments

Inquiry of Attorneys Standard Letter

Client letterhead, signed by officer List of all pending litigation ◦ Threatened ◦ Asserted or unasserted Attorney to comment on each matter Disclose matters not listed by client Informing attorney of their responsibility to client & giving permission to respond to auditor Requirements of FAS 5

Analytical Procedures (6)

Compare expenses with prior years Compare A/P balances Compare vendor balances over several periods Look at timeliness of payments Analysis of discounts taken Calculate ratios—purchases/accts. pay or expenses as a % of sales

Property, Plant, & Equipment - Substantive Testing Analytic review (2)

Compare to prior year Compare to budget

Cash - Substantive Presentation/Disclosure (4)

Compensating balances Cash equivalents policy Withdrawal/usage restrictions Amounts not federally insured

FINANCING CYCLE Equity - Substantive Testing Agree to GL (1)

Completeness

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) All ledgers, journals, and other detail foot

Completeness

Pre-numbered/sequentially numbered generally gets at:

Completeness

TOC/STOT -Transaction-Related Audit Objectives Existing payroll transactions are recorded

Completeness

FINANCING CYCLE Equity - Substantive Testing Review stock books (if no transfer agent) & trace to GL (4)

Completeness Existence Obligations Presentation & disclosure

FINANCING CYCLE Equity - Substantive Testing Foot (2)

Completeness Valuation/Allocation

FINANCING CYCLE Equity - Substantive Testing Confirm shares outstanding with transfer agent (4)

Completeness Existence Obligation Presentation

FINANCING CYCLE Equity - Substantive Testing Account for proceeds on stock issuance -trace to bank statement and GL (4)

Completeness Existence Obligations Presentation & disclosure

FINANCING CYCLE Debt - Substantive Focus is on?

Completeness and accuracy

FINANCING CYCLE Debt - Substantive Trace ending balances to GL

Completeness/ detail tie-in

23-25 (Objective 23-5) McNeil Company, a medium-sized manufacturer of microwave ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO, who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in actively-traded equity securities but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell. In planning for the current year's audit engagement, you note the following related to the investments in financial instruments: 1. The CEO discusses the investment strategy with the board of directors, but the board is not involved in the purchase and sale decisions and does not approve derivative contracts. The CEO enters into the speculative derivative financial instruments on behalf of McNeil Co. 2. Total investments in financial instruments at year end represent approximately 15 percent of total assets. The majority of investments are equity securities, and many of the equity investments are considered high-risk stocks. 3. McNeil Co. has recorded significant gains on sales of financial instruments. 4. The new CEO has an incentive to continue to grow the company and report a profit because he has been given an incentive bonus based on return on assets. Required B. Identify at least two audit procedures the auditor would perform to test the existence balance-related audit objective for the securities.

Confirm equity investments held at year end with the broker. For derivative financial instruments, auditor would review underlying documents and possibly confirm with counterparty.

Substantive Testing of Inventory Rights and Obligations (2)

Confirm offsite inventory Consigned goods

What can receipts of bank confirmations verify?

Confirms usually verify loan information on the same form

Movement Through the Cycle - Controls Conversion (WIP) (4)

Controlled with master production schedule (what will be produced & how much) Job tickets (labor & machine hours for production) Process standard costs Report scrap

Internal controls over cash balances in the general are account are divided into what 2 categories?

Controls over transactions cycle affecting the recording of cash receipts and cash disbursements Independant bank reconciliations

Cash - Substantive Cut-off procedures (3)

Cut-off bank statement (partial period statement or online access provided directly to CPA firm by bank) Review subsequent period bank statement Auditors use information in the cut-off/subsequent bank statement to verify the appropriateness of reconciling items on the bank rec

Polling Question #2: The starting point for testing the balance in the general bank account is to obtain: A. A cutoff bank statement directly from the bank B. The client's year-end bank statement C. The bank confirmation received directly by the auditor D. The bank reconciliation(s) from the client

D. The bank reconciliation(s) from the client

*For each audit procedure, identify the balance-related audit objective(s) it partially or fully satisfies. 2. Obtain a list of aged accounts receivable, foot and cross-foot the list, and trace the total to the general ledger

DETAIL TIE-IN

Accumulated Depreciation - Substantive Testing Obtain schedule from client (3)

Date, life, & depreciation method Beginning balance, depreciation expense, dispositions, & ending balance Foot & agree totals to GL

Property, Plant, & Equipment - Substantive Testing Obtain Schedule (Fixed Asset Master File) from Client (3)

Date, life, & depreciation method (tax & f/s) Beginning balance, additions, dispositions, & ending balance Foot & agree totals to GL

A/R Detail Tests should satisfy the balance-related audit objectives. First a ____________ should occur (want to make sure that you are sampling from a good population), then we are testing for - existence, completeness, accuracy, classification, cutoff, realizable value and rights.

Detail tie-in

23-25 (Objective 23-5) McNeil Company, a medium-sized manufacturer of microwave ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO, who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in actively-traded equity securities but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell. In planning for the current year's audit engagement, you note the following related to the investments in financial instruments: 1. The CEO discusses the investment strategy with the board of directors, but the board is not involved in the purchase and sale decisions and does not approve derivative contracts. The CEO enters into the speculative derivative financial instruments on behalf of McNeil Co. 2. Total investments in financial instruments at year end represent approximately 15 percent of total assets. The majority of investments are equity securities, and many of the equity investments are considered high-risk stocks. 3. McNeil Co. has recorded significant gains on sales of financial instruments. 4. The new CEO has an incentive to continue to grow the company and report a profit because he has been given an incentive bonus based on return on assets. Required C. How would the auditor test the completeness balance-related audit objective for the speculative derivative financial instruments?

Difficult to test completeness for derivative contracts since they usually do not involve an exchange of cash up front but represent a commitment to perform in the future. To test completeness the auditor could request that the counterparty provide info related to the terms and ask if there are any side agreements. Auditor should also read other financial instrument contracts to search for embedded derivatives and would read BOD minutes for discussion of derivative contracts. Finally, auditor would search the following year-end for settlement of any contracts that should have been recorded at year end.

Testing Controls Over Inventory Valuation/Allocation Process to record/account for: (5)

Direct materials Direct labor Obsolescence Manufacturing overhead allocated Standard costs vs. actual

Vendor's Statement

Document prepared monthly by the vendor and indicates the beginning balance, acquisitions, returns/allowances, payments to vendor and ending balance.

Debit Memo

Document received from the vendor and indicates a reduction in the amount owed because of returned goods or an allowance granted. Supports reductions in accounts payable (rather than increases).

Vendor's Invoice

Document received from the vendor and shows the amount owed for an acquisition. Lists the description, quantity of goods and services received, price (including freight), cash discount terms, date, amount, etc.

Purchase Order

Document used to order goods and services from vendors. Includes the description, quantity, and related information for goods and services the company intends to purchase and is often used to indicate authorization of the acquisition. Companies may submit PO's electronically to vendors with EDI.

Purchase Requisition

Document used to request goods and services by an authorized employee.

Existence - any _____________ items?

Duplicative/fictitious

*For each misstatement, identify the balance-related audit objective to which it pertains. 3. One accounts receivable in the accounts receivable master file is included on the aged trial balance twice.

EXISTENCE

*For each audit procedure, identify the balance-related audit objective(s) it partially or fully satisfies. 1. Request 30 positive confirmations of accounts receivable

EXISTENCE & ACCURACY

*For each audit procedure, identify the balance-related audit objective(s) it partially or fully satisfies. 4. Perform alternate procedures on accounts not responding to second requests by examining subsequent cash receipts documentation and shipping reports or sales invoices

EXISTENCE & ACCURACY

Fraudulent Payroll TESTS FOR FRADULENT HOURS (3)

Employee reports more time than was actually worked Hard for auditor to detect - client needs to have controls to prevent Audit software can be used to test the reasonableness of hours worked or total pay and follow up on unusual trends/amounts.

Payroll Cycle - Overview Since controls are generally good, auditors emphasize tests of controls, substantive tests of transactions and analytical procedures. Even though tests of controls and substantive tests of transactions are the most important parts of testing payroll, tests in this area are usually not extensive because there is minimal risk of misstatement due to: (3)

Employees are likely to complain if they are underpaid Payroll transactions are typically uniform and uncomplicated Again, subject to audit by federal and state govt's

Accrued Liabilities

Estimated unpaid obligations for services or benefits that have been received before the balance sheet date. Similar to auditing accounts payable

Recognized Subsequent Events

Events that provide additional evidence about conditions that existed at the balance sheet date, including estimates inherent in the process of preparing financial statements. Requires and adjustment in F/S

Property, Plant, & Equipment - Substantive Testing Test Beginning Balance (Existence) (1)

Examine assets or agree to prior year

Financial Instruments - Substantive Testing Valuation/Allocation (5)

Examine broker statements Analytical procedures on dividend & interest income Market value - pricing (verify quoted market prices and consider using a specialist for testing fair value estimates) Test management's assumptions related to valuation Impairments - very complex accounting rules

Alternative Audit Procedures to Confirmation (3)

Examine subsequent receipts & trace to bank deposit Examine invoices & contracts Examine shipping documents/ service records

Property, Plant, & Equipment - Substantive Testing Test Additions (Existence, Valuation, Rights, Cut-off) --- this is a primary area of focus when auditing equipment because these assets have a long-term effect on the financial statements. Failure to capitalize impacts both the balance sheet and income statement until the asset is fully depreciated/disposed. (3)

Examine supporting docs Qualification for capitalization Examine assets

Audit of Cash Balances Types of Cash Accounts: Cash equivalents

Excess cash accumulated during certain parts of the operating cycle that will be needed in the reasonably near future is often invested in short-term, highly liquid cash equivalents such as - time deposits, certificates of deposits & money market funds.

Balance Related & Transaction Related Objectives Balance related -> Balance Sheet

Existence Completeness Classification Rights & Obligations Net Realizable Value Accuracy Detail Tie-in Cut-off

Audit objectives

Existence Rights Valuation - gross, net Cutoff (accuracy)

FINANCING CYCLE Debt - Substantive Vouch borrowing & repayment transactions to terms and recorded amount (3)

Existence Completeness Obligation

FINANCING CYCLE Debt - Substantive Objectives (4)

Existence Completeness Obligations Presentation & disclosure

FINANCING CYCLE Equity - Substantive Testing Examine articles, bylaws, minutes - # of shares, dividends, splits, options, par, etc. (4)

Existence Completeness Presentation Obligations

Prepaid Expenses (Assets) Client Schedule (2)

Existence, Cut-Off Analytic review

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Related party transactions

Existence, Presentation/Disclosure

Polling Question #1: Which of the following is likely to be detected during an audit of a client's bank reconciliation? Payment to an employee for more hours than he worked Failure to bill a customer Failure to record a collection of a note receivable by the bank on the client's behalf An embezzlement of cash by intercepting cash receipts from customers before they are recorded

Failure to record a collection of a note receivable by the bank on the client's behalf

Final Evidence Accumulation (8)

Final overall analytic review Going-concern evaluation (one year beyond balance sheet date) Summary of passed entries Review ◦ Seniors review throughout ◦ Managers review throughout and at near end of fieldwork ◦ Partners near end & after fieldwork (includes concurring review) Disclosure checklist Propose audit adjustments & disclosures Read all other information in annual report (required by auditing standards) Issue report - overall conclusion on the f/s. Has the auditor accumulated sufficient evidence to warrant the conclusion that the financial statements are stated in accordance with accounting standards

______________ are defined as: a tradable asset of any kind - such as, debt securities, equity securities, and derivative instruments Business risks associated with financial instruments will vary depending on the ____________ and _____________ of a company's investing activity. _________ will be higher for companies investing in less liquid securities or derivative financial instruments (financial services firms are exposed to greater risk due to the sheer volume of activity and types of instruments traded) Majority of financial instruments are valued using ______________?

Financial Instruments Significance Aggressiveness Risks Fair Value Estimates

Audit of Cash Balances Types of Cash Accounts: General cash account

Focal point of cash for most businesses because virtually all cash receipts and disbursements flow through this account

Obtain Bank Reconciliations for Fiscal Year End (FYE) (4)

Foot Tie book balance to GL Confirm bank balance Investigate significant O/S checks, DIT and other reconciling items not clearing the subsequent bank statement(s)

Sales Cycle-Analytical Procedures Compare financial information (4)

Gross Margin Analysis Sales by Month by Product Aging Analysis Days A/R Outstanding & Turnover

23-25 (Objective 23-5) McNeil Company, a medium-sized manufacturer of microwave ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO, who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in actively-traded equity securities but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell. In planning for the current year's audit engagement, you note the following related to the investments in financial instruments: 1. The CEO discusses the investment strategy with the board of directors, but the board is not involved in the purchase and sale decisions and does not approve derivative contracts. The CEO enters into the speculative derivative financial instruments on behalf of McNeil Co. 2. Total investments in financial instruments at year end represent approximately 15 percent of total assets. The majority of investments are equity securities, and many of the equity investments are considered high-risk stocks. 3. McNeil Co. has recorded significant gains on sales of financial instruments. 4. The new CEO has an incentive to continue to grow the company and report a profit because he has been given an incentive bonus based on return on assets. Required A. Identify the inherent and control risks related to the financial instruments accounts for McNeil Co.

IR is increased by: the investment in speculative derivative financial instruments; CEO receives incentive bonus based on ROA which provides incentive to generate a profit (remember that McNeil recorded sizable gains on sales); CEO doesn't have prior experience investing in complex instruments and they account for ~15% of total assets which is a material amount. CR is increased by: CEO is making investment decisions without any monitoring; CEO discusses strategy with BOD and a brokerage firm executes the trades but the BOD doesn't approve the investments in advance; no limits on CEO's ability to enter into such transactions. CR is reduced by the fact that they use a brokerage firm to execute trades (assuming internal controls at brokerage firm have been tested and are considered effective).

Payroll - Tests of Details of Balances EXPENSE ACCOUNTS - extensive additional testing of related _____________ accounts are necessary only when auditors uncover ___________ deficiencies/material weaknesses in internal control, significant misstatements in liability tests or major unexplained variances in analytical procedures.

Income statement Significant

Write-Offs - Controls (4)

Initiated by credit manager Approved by authorized person Turned over to collections Sequential documentation

Sales and Collection Cycle A customer's request for goods (assume merchandising or manufacturing client) does what?

Initiates the entire cycle

The Financing cycle Income Statement (1)

Interest Expense

FINANCING CYCLE Debt - Substantive Obtain an analysis of __________

Interest bearing debt

Payroll and Inventory When payroll represents a significant portion of ________ (common for manufacturing and construction companies) - it impacts asset valuation for accounts such as WIP, finished goods or construction in process. For example - valuation of _________ is affected if direct labor cost of individual employees is incorrectly charged to the wrong job or process. When jobs are billed at a ___________, revenue and the valuation of inventory are both affected. Need to test internal controls over proper classification - such as reviewing job tickets or tracing other evidence of an employee having worked on a job or process to the accounting records.

Inventory Inventory Cost-plus basis

Flow of Inventory Costs Shipping is often the most complex and time-consuming part of the audit due to the fact that:

Inventory is often the largest account on the B/S, it is often in different locations, diverse items can be hard to value, different acceptable inventory valuation methods.

Financial Instruments — Substantive Testing Starting point for testing the ending balance of financial instrument accounts is to obtain a schedule of ____________ for the year. The schedule should include ______________, purchases and sales of financial instruments (and any gain/losses), and ending balances recorded at _________________. The schedule will also show ______________________ income (often tested using analytical procedures)

Investment activity Beginning balances Fair market value Dividend and interest

Sales and Collection cycle

Involves the decisions and processes necessary for the transfer of the ownership of goods and services to customers after they are made available for sale; it begins with a request by a customer and ends with the conversion of material or service into an account receivable, and ultimately into cash

Sales Cycle-Substantive Tests What's the problem with revenue recognition?

It is often misapplied - (Which is often misapplied)

Vouch vs. Trace

Let's first cover the definitions. These are both terms that are used in financial auditing. So an accountant will come into a business, look at their accounting records, and evaluate how accurate they are. That's what an audit is. And two of the procedures that are performed are Tracing and Vouching. Tracing looks at a financial document and traces the path of that document all the way to the financial statements. Vouching goes the opposite direction. Vouching starts with a number on the financial statement and then you find the original document that supports that number. The key to understanding these terms is direction. Tracing goes towards the financial statements. Vouching goes away from the financial statements. So you really just have to memorize the direction. Now it is also important to understand what these procedures are trying to prove. Tracing provides evidence for completeness. Vouching provides evidence for occurrence. It is easy to get this confused, but the direction tells you different things. If you trace from a document to the financial statement, it tells you completeness but not occurrence, because there are pieces of that overall financial statement number we haven't looked at. We only traced one document. And going the other direction, we find the opposite. Vouching tells you occurrence, but not completeness. This is because you might be missing an original document, and you never know, because it was never included in your financial statement number to begin with. So here is my tips for remembering these: Now this may seem silly, but it works. Tracing. Let's do tracing first. It comes first alphabetically so it makes sense to start there. Tracing starts with a t. A t, can look a little like an arrow. What do you do with an arrow? You shoot it towards a bullseye. What is the bullseye for an accountant? It is your financial statements. So the direction for tracing is towards the financial statements. Now let's look at Vouching. When you vouch for something, what are you saying? You are backing up someone's statement. So vouching goes the direction away from the statement. You are starting with the statement, and you are vouching, or backing that statement up with evidence.

Adapted From Discussion Question 14-25 Business A - STARBUCKS. Customers use cash, debit cards, credit cards or pre-paid Starbucks cards to purchase drinks that are served within minutes. Business B - AMAZON. Huge selection of products purchased through on-line site. Business C - PHYSICIAN. Examines patients and prescribes treatment/medicine as needed. Insured patients pay with co-pay and balance paid by insurance company Business D - UNIVERSITY. Significant portion of revenue from tuition. Bill students in advance for upcoming term. 3) For which of the above businesses would the write-off of uncollectible accounts and bad debt expense function be N/A?

Limited for Starbucks and Amazon since mostly debit/credit card purchases

FINANCING CYCLE Debt - Substantive Make sure notes were paid at __________

Maturity

Confirmation Procedures Mail second & often third requests (2)

May be verbal (telephone) Use fax machine with caution (auditor location)

Movement Through the Cycle - Controls Finished Goods Storage

Monitor transfer

Importance of Income Statement?

Most users of f/s rely more heavily on the income statement

*For each misstatement, identify the balance-related audit objective to which it pertains. 5. The allowance for uncollectible accounts is inadequate because of the client's failure to reflect depressed economic conditions in the allowance.

NET REALIZABLE VALUE

Cash Separation of Duties (5)

No one person handling a transaction from beginning to end Cash handling separate from record-keeping Record receipts timely Deposit timely Reconcile bank accounts • Timely • No custody of cash or checks • No record-keeping • Independently reviewed

Transaction-Related Audit Objectives Completeness

Not a huge risk for sales process. Confirm that sales listing is complete and A/R balance is complete. Any omitted transactions?

Types of Confirmation Negative (2)

Not returned unless there is an exception Must meet certain criteria to utilize ◦ Large number of small accounts ◦ Low control risk ◦ Likely to be considered by recipient

Audit Decisions In summary, what are the auditor's main decisions regarding the physical observation of inventory (assuming client has a significant inventory balance)? SELECTION - Auditors should be careful to: (3)

Observe the counting of the most significant items and have a representative sample of typical inventory items Inquire about items that are likely to be obsolete or damaged Discuss with management the reasons for excluding any material items

Balance Related & Transaction Related Objectives Transaction Related -> Income statement

Occurrence Completeness Classification Accuracy Posting & Summarization Timing

Sales Cycle - Analytical Procedures Analytical Procedure: Compare sales returns and allowances as a percentage of gross sales with previous years (by product line) Possible Misstatement: ?

Overstatement or understatement of sales returns and allowances and accounts receivable

Financial Instruments — Substantive Testing Rights

Ownership—pledged as collateral? Confirmation

Fraudulent Payroll FRAUDULENT EXPENSE REPORTS (2)

Pay particular attention to travel and entertainment reports for officers and directors --- why? Examine receipts, understand reason for expense, verify approval and determine whether the reimbursements are within company guidelines

Payroll - Substantive Testing Cut-off (Timing) (2)

Pay period vs. financial period Bonus payout

Payroll - Substantive Testing Presentation and Disclosure (1)

Pensions, stock options, employment agreements, etc.

Auditor should _______________ to verify the addresses and emails used for confirmations (especially P.O. boxes and when an email is inconsistent with company's website or usual email addresses)

Perform procedures

Transaction-Related Audit Objectives Timing

Perform testing before and after year end to ensure that sales/receivables are recorded in the correct period (ensure books were not kept open after period end)

Cost Accounting Controlled by G/L accounts (2)

Perpetual inventory records (Should be maintained by persons who do not have custody or access to assets. The reliability of perpetual inventory master files affects the timing and extent of the auditor's physical examination of inventory. If they are deemed accurate, interim testing can be used/effective.) Segregation of duties (accounting vs. access)

Adapted From Discussion Question 14-25 Business A - STARBUCKS. Customers use cash, debit cards, credit cards or pre-paid Starbucks cards to purchase drinks that are served within minutes. Business B - AMAZON. Huge selection of products purchased through on-line site. Business C - PHYSICIAN. Examines patients and prescribes treatment/medicine as needed. Insured patients pay with co-pay and balance paid by insurance company Business D - UNIVERSITY. Significant portion of revenue from tuition. Bill students in advance for upcoming term. 2) For which of the above businesses would the sales returns and allowances business function not be applicable?

Physicians. Limited returns (just merchandise) at Starbucks

Summarize Confirmation Results (6)

Population $ Number and $ Amount Document resolution of exceptions Any qualitative considerations? Projected error Conclusion

TOC/STOT -Transaction-Related Audit Objectives Payroll transactions are correctly included in the payroll master file and are correctly summarized

Posting & Summarization

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Concentration of credit risk (geographic/one customer)

Presentation/Disclosure

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Credit balances in AR to AP

Presentation/Disclosure

*For each misstatement, identify the balance-related audit objective to which it pertains. 6. The pledging of accounts receivable to the bank for a loan is not disclosed in the f/s.

RIGHTS & PRESENTATION/DISCLOSURE

FINANCING CYCLE Debt - Substantive Compliance with debt provisions/covenants (presentation & disclosure) (4)

Ratios Restrict dividends or additional debt Events of default Waiver of compliance

Cost Accounting Predetermine rates (standard costing) (2)

Raw material, direct labor, & overhead Price variances

Receiving Goods and Services Similar to Sales/Cash Receipt cycle where the shipping of goods is a critical point... In this cycle, the ______________ from the vendor is when most companies first recognize the acquisition and related liability on their records. Receiving report is prepared (if physical goods are received). Adequate _______ requires examination of goods upon arrival.

Receipt by the company of goods or services Control

Loss Contingencies Probable

Record liability if amount can be reasonably estimated If not estimable - footnote disclosure

Transaction-Related Audit Objectives Accuracy

Recorded sales are accurate and A/R is correct

Transaction-Related Audit Objectives Classification

Recorded to correct G/L account (i.e. - sales v. gains)

Accounts Payable Master File

Records acquisitions, cash disbursements, and returns/allowances transactions for each vendor. The total of the individual account balances in the master file equals the total balance of accounts payable in the G/L.

FINANCING CYCLE Equity - Controls Separation of duties & adequate records (5)

Registrar - makes sure not over-issued & authorized Transfer agent - keeps lists of investors, # shares, transfers ownership, disburses dividends. Transfer agent also ensures that stock issuances comply with the articles of incorporation and prepare stock certificates. Access to certificates (if no TA, the individual who maintains the stock certificate book should have no accounting responsibilities) Serially numbered certificates If no TA, there should be an independent reconciliation of the stock certificate book with the number of shares outstanding

Substantive Tests of Details Classification (Presentation and Disclosure) (6)

Related party transactions Long-term liabilities Current vs. long-term Operating income & expenses vs. non-operating inc/exp Debt covenants Debit balances

Prepaid Expenses (Assets) Types (typically immaterial) (3)

Rent Insurance Taxes

Confirmation procedures exceptions (5)

Resolve with client assistance Timing differences Misunderstandings Project to population Isolated errors?

Note - the allowance for AR (realizable value objective) is a specific concern because it may be used to manipulate ____________ and is an area involving estimation

Revenue

Sales Cycle-Analytical Procedures Compare non-financial information (2)

Revenue per square foot Revenue per customer

Income and Expenses Accounts for Special Consideration (6)

Revenues from unusual transactions Repairs & maintenance Rent expense Gains & losses on sales Legal & professional expense Income taxes (current & deferred)

Property, Plant, & Equipment - Substantive Testing Other tests (3)

Review Presentation & Disclosure Capitalized leases vs. rent expense Repairs & maintenance

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Sales belong to company

Rights (factoring of receivables

Cutoff (3)

Sales recorded for the last days of current period Sales recorded for the first days of subsequent period Sales returns for subsequent period

Transaction-Related Audit Objectives Posting & Summarization

Sales transactions properly included in A/R sub-ledger and summarized correctly

Sales and Collection Cycle Income Statement (4)

Sales/Revenue Sales returns, discounts and rebates Bad debt expense Cash discounts

Substantive Tests of Details Cutoff (3)

Search for unrecorded liabilities Inventory observation - any in-transit items? Any held checks

Subsequent Events Procedures (7)

Search for unrecorded liabilities Inquiry Minutes Legal letters—expected report date Review subsequent f/s Regulatory communication - IRS, etc. Representation letters

Substantive Tests of Details Completeness (3)

Search for unrecorded liabilities (out of period liability tests - ie., examination of subsequent cash disbursements - look at journal and/or subsequent bank statement) Foot A/P ledge and trace to G/L Confirm large suppliers

Timing confirmations of A/R (2)

Send out as close to balance sheet date as possible - customers are more likely to respond to current information and it can take time to get responses Allowed to test at interim and roll-forward (not always efficient)

Issuance of Inventory - Controls (3)

Separate duties ◦ Accounting (recording) of inventory ◦ From storekeeper (access) Computer accuracy controls Passwords & User IDs

Key Controls for Sales (5)

Separation of Duties (keep authorization, custody and record keeping separate) Proper Authorization Adequate Documents & Records (serially numbered bill of lading, sales invoices and receiving reports) Monthly Statements Internal Verification Procedures

Financial Instruments — Controls (5)

Separation of duties Recorded in name of company Periodic inspection of securities by internal auditor Detailed records of securities owned, purchased, sold, unrealized gains & losses & interest/dividend revenue. Process in place to value securities

Receipt of Goods/Services - Controls (3)

Sequentially numbered receiving reports (authorized by receiver) Separate receiver from stockroom & accounting Tracking & controlling physical movement of goods (while maintaining separation of duties)

Sales Returns - Controls (3)

Serially numbered credit memos - authorized by someone who does not handle cash or access/record customer ledgers Reference to serially numbered receiving report of returned merchandise Year-end cut-off

Integration of Tests Tests of Sales and Collection Cycle

Shipment/recording of sales takes place when this cycle is tested

Substantive Testing of Inventory Cutoff (4)

Shipping & receiving docs vs. recorded inventory Invoice dates vs. recorded sales & unearned revenue Returned inventory vs. sales returns recorded *NOTE: a major source of cutoff information for sales and purchases of inventory (and related A/P) is the physical observation

Sales and Collection Cycle What is the critical function?

Shipping goods Because this is the point where the company generally gives up assets and recognizes/records the sale

Concluding procedures Communication with audit committee SAS 114

Significant new policies Difficulties experienced during the audit Disagreements with management

Payroll Cycle - Overview Internal controls over payroll are effective for almost all companies (even small ones) - why? (2)

Strict federal and state regulations encourage effective controls for withholding and paying payroll taxes Employees are focused on their pay-morale problems will ensue if employees are not paid or are underpaid

Payroll - Substantive Testing Valuation/Allocation (Classification) (4)

Test allocation to inventory and cost of goods sold Accuracy of payroll rates, hours, withholdings, etc. Re-compute profit-sharing, bonus, stock option expense Test pension obligation (specialist)

Property, plant, & equipment Controls (6)

Tested in Acquisition & Payment Cycle Fixed asset master file (primary accounting record) - includes a detailed record of equipment and other property owned ID tags Physical count—internal auditors and accounting personnel Physical controls (especially over assets that are easily movable) Calculation of depreciation (important to have good controls and review the depreciation calculation since based on internal allocations rather than by exchange transactions - not already tested with cash disbursements)

Cash - Substantive Cash and cash equivalents

The company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents. The company did not have any investments considered to be cash equivalents as of December 31, 2010 and 2009

Cash - Substantive Concentration of credit risk

The company maintains its cash in bank deposit accounts which may, at times, exceed federally insured limits

Cash Receipts

The money that a business collects, e.g., business income

23-25 (Objective 23-5) McNeil Company, a medium-sized manufacturer of microwave ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO, who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in actively-traded equity securities but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell. In planning for the current year's audit engagement, you note the following related to the investments in financial instruments: 1. The CEO discusses the investment strategy with the board of directors, but the board is not involved in the purchase and sale decisions and does not approve derivative contracts. The CEO enters into the speculative derivative financial instruments on behalf of McNeil Co. 2. Total investments in financial instruments at year end represent approximately 15 percent of total assets. The majority of investments are equity securities, and many of the equity investments are considered high-risk stocks. 3. McNeil Co. has recorded significant gains on sales of financial instruments. 4. The new CEO has an incentive to continue to grow the company and report a profit because he has been given an incentive bonus based on return on assets. Required D. Identify at least two audit procedures the auditor would perform to test the realizable value balance-related audit objective for the financial instruments accounts. Assume the investments in stock are all actively-traded in a liquid market, but the derivative financial instruments require a level 3 fair value estimate.

To test fair value of equity securities, auditor would verify ending market value as listed on client's schedule to quoted market prices. For derivatives - need to understand model used by management and assess appropriateness.

Substantive Tests of Details Focus on A/P

Total amount known & owed at b/s date

Substantive Testing of Inventory Existence/ Occurrence (RECORDS TO FLOOR) (4)

Tour of facilities ◦ Done to familiarize the audit team ◦ Should be led by a supervisor Inventory Observation ◦ Auditing standards REQUIRE auditors to perform physical observations of inventory. Auditors must satisfy themselves about the effectiveness of the client's methods of counting inventory (be present at count, observe counting procedures, make inquiries and do independent tests of physical count) ◦ Auditor should also test the existence of the items on the client's inventory report sheets by vouching a sample of items from the inventory report sheet to the corresponding pre-numbered inventory tags Confirm offsite inventory Consigned goods

Fraudulent Payroll TESTS FOR NONEXISTENT EMPLOYEES (2)

Trace selected transactions recorded in the payroll journal to human resources department to determine if employees were actually employed during the payroll period Auditor may request a surprise payroll payoff. This is a procedure in which all employees must pick up and sign their check or direct deposit in the payroll record in the presence of a supervisor and auditor. Any unclaimed checks are investigated.

Payroll Cycle - Service Organizations __________ reports help auditors obtain an understanding of internal controls in order to plan the audit; however, auditors also require evidence about the operating effectiveness of controls to assess control risk - contained in a _______ report.

Type 1 Type 2

Payroll Cycle - Service Organizations Be aware that auditors must thoroughly review the ________ report (look for testing of key controls, concern with period covered by the report).

Type 2

Is the following a test of control or a STOT and what is transaction-related audit objective? Recompute hours on the time card and compare the total with the total hours for which the employee has been paid

Type of Test: Substantive test of transactions Transaction-Related Audit Objective(s): To determine if employees are paid for the hours they have worked (accuracy)

Is the following a test of control or a STOT and what is transaction-related audit objective? Reconcile monthly payroll total for direct manufacturing labor with the labor cost distribution

Type of Test: Substantive test of transactions Transaction-Related Audit Objective(s): To determine if monthly payroll costs have been correctly allocated (accuracy)

Is the following a test of control or a STOT and what is transaction-related audit objective? Perform a surprise payroll payoff and observe employees picking up and signing for their checks

Type of Test: Substantive test of transactions Transaction-Related Audit Objective(s): To determine if payments are made to actual employees (occurrence)

Is the following a test of control or a STOT and what is transaction-related audit objective? Compare the employee name, date, check number and amounts on cancelled checks with the payroll journal

Type of Test: Substantive test of transactions Transaction-Related Audit Objective(s): To determine if the appropriate person is paid and amount and time are correct (accuracy and timing)

Is the following a test of control or a STOT and what is transaction-related audit objective? Compare the hours from the employee time cards to job tickets to make sure that the total reconciles and trace each job ticket to the job-cost record

Type of Test: Substantive test of transactions Transaction-Related Audit Objective(s): To determine if the correct job is charged for labor and if the amount is recorded correctly for each job (classification and accuracy)

Is the following a test of control or a STOT and what is transaction-related audit objective? Use audit software to account for the sequence of payroll checks in the payroll journal

Type of Test: Test of control Transaction-Related Audit Objective(s): To determine if all payroll checks are recorded (completeness)

Is the following a test of control or a STOT and what is transaction-related audit objective? Examine the time card for the approval of a foreman

Type of Test: Test of control Transaction-Related Audit Objective(s): To determine if recorded payroll transactions are for work actually performed by existing employees (occurrence)

FINANCING CYCLE Equity - Substantive Testing Presentation and Disclosure (10)

Type of issue (common, preferred) Voting rights Par value Number of shares authorized, issued & outstanding Liquidation rights Preference Dividends Dividends in arrears Treasury stock Stock option plans

Loss Contingencies Reasonably possible

Typically not estimable Footnote disclosure required

Sales and Collection Cycle Write off what?

Uncollectible A/R

Sales Cycle - Analytical Procedures Analytical Procedure: Compare bad debt expense as a percentage of gross sales with previous years Possible Misstatement: ?

Uncollectible accounts receivable that have not been provided for

Voucher

Used by a company to establish a formal means of recording and controlling acquisitions, primarily by enabling each acquisition transaction to be sequentially numbered. Includes a package of relevant documents such as PO, copy of packing slip, receiving report and vendor's invoice (and payment copy may be added to this package later).

Audit of Cash Balances Types of Cash Accounts: Petty cash

Used for small acquisitions

Other Considerations (Legend: Existence, Presentation/Disclosure, Valuation - Gross, Valuation - Net, Completeness, Rights, Cut-off) Pricing of sales - inventory

Valuation - Gross

Payroll - Substantive Testing Existence/Occurrence (4)

Vouch payroll transactions from GL to timesheets Non-existent employees and fraudulent hours Examine employment contracts, pension plan, 401K plan, bonus & pay raises in board meeting minutes, stock option plan Analytical procedures - prior year comparisons, % of sales, average pay per employee

Financial Instruments - Substantive Testing Cutoff

Vouch purchases & sales, verify cutoff

Accounting/GL - Controls (6)

Voucher packet matching Checking accuracy & initialing Separate accounting duties from authorization Invoices properly authorized Voucher packets cancelled (no duplicate payments) Testing IT System controls

The Payroll Cycle Income Statement (2)

Wages, salaries, bonuses, & commissions Employee benefits

Subsequent Events - Registration Statements S-1 Review

When a company issues new securities, the auditor is associated with the registration statement. Therefore we must review all information in the registration statement and extend our subsequent events review through the effective date of the registration statement.

23-25 (Objective 23-5) McNeil Company, a medium-sized manufacturer of microwave ovens, has been an audit client for the past five years. McNeil Co. has been steadily growing and recently hired a new CEO, who has decided to increase the level of investments in financial instruments as a way of generating a profit from excess cash from operations. The new CEO has invested primarily in actively-traded equity securities but has also invested a portion of the cash in speculative derivative financial instruments. McNeil Co. is using a brokerage firm to execute trades, but the CEO is making the decision as to which securities and derivatives to purchase and sell. In planning for the current year's audit engagement, you note the following related to the investments in financial instruments: 1. The CEO discusses the investment strategy with the board of directors, but the board is not involved in the purchase and sale decisions and does not approve derivative contracts. The CEO enters into the speculative derivative financial instruments on behalf of McNeil Co. 2. Total investments in financial instruments at year end represent approximately 15 percent of total assets. The majority of investments are equity securities, and many of the equity investments are considered high-risk stocks. 3. McNeil Co. has recorded significant gains on sales of financial instruments. 4. The new CEO has an incentive to continue to grow the company and report a profit because he has been given an incentive bonus based on return on assets. Required E. In your opinion, would the audit of financial instruments require the use of a valuation specialist? Why or why not?

Yes, highly likely

Audit of Cash Balances Types of Cash Accounts: Imprest payroll account

as a means of improving internal control, many companies establish a separate imprest bank account for making payroll payments to employees. In such an account, a fixed balance (ie. $1,000), is maintained. Immediately before each pay period, one check is drawn on the general cash account to deposit the total amount of the net payroll in the imprest account.