Auditing

The purpose of well-defined corporate governance is to encourage management to maintain an ethical operation and to adhere to

"best practices"

The Fraud Triangle

1. They have a financial need. This could be a business need or a personal need and is often a need that they know of no legitimate way to resolve. The employee may feel the need is so dire that they cannot share the problem with anyone. 2. They see an opportunity they feel is relatively safe from being detected. This is when the person uses (abuses) their position of trust secretly. For example, an employee who has access to cash might feel they have the opportunity to "borrow" some cash because they feel they will be able to repay it before they are caught. 3. They are able to rationalize the crime by convincing themselves that they are somehow entitled. For example, an employee might rationalize stealing because he feels he should have received a better raise.

Are companies required to have an audit? if yes, how often?

Any company whose stock is traded on a public exchange is required by the Securities & Exchange Commission (SEC) to have an annual audit. Other companies may also want or need an audit, possibly because of requirements of bankers or others who have invested in the company. Also, stockholders who are not involved in the operations of the business may want an audit to give them confidence in the company's financial statements.

Sarbox implications for companies

Audit committee: Oversight of internal audit Independent & one must have financial expertise Hires & receives report from independent auditors Limits on loans made to executives Section 404 internal control audit required Section 302 holds management responsible

5 elements of internal controls

Control environment, or the "Tone at the top" Management must set an ethical tone for its employees. Risk assessment The company must realize the risks it faces and take steps to control the risks. Control activities The company must establish procedures & policies to protect its assets. Information & communication The policies & procedures must be communicated to employees. Monitoring There must be continual follow up to see how the procedures are working and to make any necessary modifications.

refers to the laws and rules in place which determine how a company operates. Broadly speaking, this term refers to both internal factors, such as the officers, stockholders, or bylaws of the corporation, and external factors, such as customers, consumer groups, and the law

Corporate Governance

categories of internal controls

Effectiveness and efficiency of operations Reliability of financial reporting Compliance with applicable laws and regulations

In 2001, one on the largest (and what the world perceived to be the one of the most successful) companies, __________, collapsed. Along with it went the highly-acclaimed CPA firm which had been the external auditor, ________. Shortly afterwards

Enron, arthur anderson

In an audit what is the responsibility of the company? What is the responsibility of the auditor?

Preparation of the financial statements is the responsibility of the company being audited. It is the auditors' job to express an opinion on the statements management has prepared.

Internal controls are procedures or systems which are designed to:

Promote efficiency Safeguard assets Avoid fraud and errors Keep accounting data accurate

This is a nonprofit corporation controlled by the SEC, and all companies which provide audit services to publicly-traded companies are required to register with it. The purpose of the __________ is to regulate, watch over, and if necessary, discipline public accounting firms.

Public Company Accounting Oversight Board (PCAOB)

What do auditors use to determine if there are any material misstatements?

To make this determination, the external auditors must gather and evaluate sufficient information, called audit evidence. The audit evidence needs to be of sufficient quantity and quality so the auditors are able to form an opinion based on the information they have evaluated. Notice that the auditors are not guaranteeing that the financial statements are absolutely correct. Instead they are stating that they have conducted sufficient tests to allow them to issue an opinion that the financial statements do not contain any material errors.

sampling

Using a random subset of the population in order to form an opinion on the population as a whole.

11. A public company that is traded on a major U.S. stock exchange a. must have an audit prepared once a year by an independent auditor. b. refers to a company that is owned at least partially by the government. c. must have their managerial statements audited at least annually by an independent auditor. d. may elect to have their annual audit prepared by the company's internal audit staff. e None of the above

a

13. Which of the following is not true regarding the audit committee? a. Its main purpose is to report any misdeeds within the company to the United Nations. b. Its members cannot be employees of the company. c. Its function was strengthened by Sarbanes-Oxley. d. The internal auditor reports to the audit committee. e. One or more members must have financial expertise.

a

15. A "compilation" by an auditor means that the auditor a. only compiled the records of the company into financial statements, and did not verify the accuracy of the underlying transactions. b. verified that the company's records were accurate before compiling the company's records into financial statements. c. did an audit of the company's records before compiling the company's records into financial statements. d. hired one of the company's employees to compile the financial statements for the company. e. did an audit of the company's records after compiling the company's records into financial statements.

a

7. Which of the following sections of SARBOX requires that top management of a publicly- held company must bear responsibility for its financial statements? a. Section 302 b. Section 203 c. Section 404 d. Section 204 e. Section 304

a

Sarbanes-Oxley requires a. the lead auditor to rotate every five years. b. creation of GAAP by the IRS. c. the audit committee to report directly to the compensation committee of the board of directors. d. a panel of 12 judges to evaluate the audit opinion before it can be issued. e. None of the above

a

material misstatements

an error significant enough that it would mislead the reader.

One of the most common services provided by Certified Public Accountants (CPA's) is the

audit

This is a committee of the board of directors and its purpose is to work with the independent auditors. The committee is in charge of hiring the external audit firm and regulating its work. Rather than reporting to management, the external auditors now report directly to the audit committee.

audit committee/supervisory committee

refers to the possibility that the auditors fail to realize that there is a material misstatement in the financial statements. This is the risk that the auditors indicate the financial statement give a true and fair picture of the status of the company when the statements are, in fact, misleading

audit risk

qualified

auditors find something that needs to be modified, but otherwise in compliance

With respect to auditing, management is responsible for a. the opinion rendered by the external auditors. b. the financial statements. c. research and development of environmentally-safe end-product recovery systems. d. assuring that external auditors are truly independent. e. absolutely nothing.

b

refer to the techniques or methods that have been proven to lead to desired results. When a company makes a commitment to follow the ___________, it is making a commitment to use the most current information and technology available to reach a desired result.

best practices

. The letter in which an external auditor attests to whether or not a company has prepared its financial statements according to GAAP is referred to as either "modified" or "unmodified". The letter itself is called an audit a. rendition. b. compilation. c. opinion. d. performance. e. operation. 

c

. Which of the following is not one of the levels of assurance for which a CPA may be engaged by a client? a. audit b. review c. examination d. compilation e. All of the above are levels of assurance

c

14. Which of the following is not true regarding independent audits of public companies? a. The auditor forms an opinion of the overall fairness of the financial statements. b. The financial statements are the responsibility of the company's management. c. The most favorable opinion an auditor can present is the "modified opinion". d. An annual independent audit is required of public companies. e. Strong internal controls can reduce the independent audit fee.

c

can only be used when the readers of the company's financial statements do not need the assurance that comes with a review or audit. However, the CPA is still obliged to consider whether the financial statements are appropriate in form and free of obvious material errors

compilation

gives the reader of the financial statements no assurance from the CPA. Instead, the independent accountants have been hired only to put together, or compile, the financial statements from the books and records of the company. These statements may be prepared on a monthly, quarterly, or annual basis

compilation

3 services auditors can provide

compilation review audit

5 elements of internal control process

control environment risk assessment control activities info and communication monitoring

10. Sarbanes-Oxley a. came about as a result of the stock market crash in 1929. b. has jurisdiction over all corporations operating in the United States. c. lessens the role of independent auditors. d. requires the periodic rotation of the lead independent auditor. e. None of the above

d

After a company's financial statement have been audited by an independent CPA firm, a. the reader of the statements will know the numbers on the statements are accurate to the nearest penny. b. the financial statements are the sole responsibility of the CPA firm conducting the audit. c. the reader of the statements will know that any fraudulent activity would have been discovered. d. the statements will have more credibility to an outside party that they otherwise would have. a. None of the above

d

The examination that is required under section 404 of Sarbanes-Oxley is an audit of a. BAAP b. CEO and CFO integrity c. compensation rules d. internal controls e. revenue recognition criteria

d

The two sections of Sarbanes-Oxley that most business people know by section number are a. 204 and 304. b. 203 and 404. c. 204 and 303. d. 302 and 404. e. None of the above

d

12. Sarbanes-Oxley a. requires a second partner to review and approve audit reports. b. established the Public Company Accounting Oversight Board (PCAOB). c. increased senior management's responsibility for published financial statements. d. required that an audit of internal controls be conducted. e. accomplished all of the above.

e

An external auditor's opinion conveys good news (rather than bad) if it is a. certified b. quantifiable c. qualified d. modified e. unmodified

e

Financial audits are performed by

external, independent auditors who are certified public accountants (CPA's).

When CPAs audit financial statements, their work must be in accordance with

generally accepted auditing standards (GAAS). The purpose of these standards is to help insure that audits performed by various CPAs will be as uniform as possible. The standards were originally written in 1947 and were very broad. Since then, more detailed interpretations have been added to give auditotrs more guidance

section 302

in quarterly and annual financial statements, management must: certify the internal controls over financial reporting, state responsibility for IC design, provide reasonable assurance as to the reliability of the financial reporting process, and disclose any recent material changes in IC

Audits are performed by

indépendant/external auditors

Audited financial statements are the accepted manner in which companies report the status of their operations to

interested parties outside the company

Most companies employ

internal auditors

In conducting an audit, the auditors must rely on the company's

internal controls.

The compilation report from the CPA that accompanies the financial statements is required to include a statement that states

no review or audit was performed and that the statements may not be appropriate for outside readers.

The law requires a ______ waiting period before a client can hire an auditor as its employee in the positions of CEO, CFO, chief accounting officer (CAO), or controller.

one year

A review may be used instead of an audit by companies whose stock is

privately held

Materiality

relates to the potential impact that a misstatement could have on the financial statements

occurs when less than one-hundred percent of an account balance or a class of transactions is verified by the auditors.

sampling

While auditors have always needed to rely on a company's internal controls, ________ of Sarbanes-Oxley now requires that auditors go one step further and render an opinion on the quality of the company's internal controls.

sec 404

requires management to sign a statement as to the effectiveness of the company's internal controls. It is a federal crime for directors or officers of the company to pressure an auditor to issue misleading financial statements.

section 302

In a company, who elects the board of directors

stockholders

Sarbanes-Oxley prohibits auditors from providing a myriad of services to the companies they audit. This includes such things as bookkeeping services, financial information systems design, appraisals, valuations, management functions, and human resources but does allow

tax services

To conduct a financial audit means

to carry out a thorough examination of an entity's books and records, financial accounts, and policies and procedures.

In a financial audit, the objective is

to form an opinion on the financial statements produced by the management of the company.

In accounting, to audit an entity means

to thoroughly examine the bookkeeping records, financial accounts, and the policies and procedures of that entity. An "entity" could be a partnership, corporation, trust, or governmental unit.

3 opinions auditors can give

unmodified qualified adverse disclaimer of opinion

The most common audit opinion is

unmodified- in compliance

What is the Internal auditor's main responsibility

It is the internal auditor's job to find any problems that the external auditors might come across and try to get these problems corrected before the external auditors arrive. One of the ways internal auditors do this is by creating and managing internal controls.

tone at the top

It recognizes that the basis of any business is its employees and their integrity, ethics, and competence and that management has the power to have a major influence on these.

section 404

Makes the annual financial reports include: a statement that management acknowledges its responsibility for establishing and maintaining an adequate internal control structure and procedures for financial reporting, an assessment, as of the end of the fiscal year, of the effectiveness of the internal control structure and procedures for financial reporting, and an attestation by the company's auditor that the assessment made by the management is accurate.

In a typical financial audit, there are several areas the auditor is attempting to verify. These include the following:

1. Are all assets and liabilities which should be on the balance sheet recorded correctly and are the balances in these accounts accurately reflected on the balance sheet? 2. Are all assets and liabilities that are reported on the balance sheet correct in that they are in existence at the date of the statement and that the entity being audited is the owner of these assets and liabilities? 3. Are all assets and liabilities disclosed and classified correctly with the description being clear and not misleading to the reader of the financial statements? 4. Are all transactions of the period reported in accordance with GAAP or IFRS? 5. Are any amounts entered inappropriately as transactions?

Sarbox Indications for Auditors

7-year workpaper retention Second partner review "Quality review" by PCAOB every year of the auditors Can't provide consulting services to audit clients Report to the audit committee Lead auditor must rotate every 5 years One-year wait before auditor can go to work for client

What is a review

A review is another service provided by CPAs. It gives the reader limited assurance, less than with an audit, because the CPA conducts fewer tests on the entity's books and records. In a review, the CPA is attempting to assess only (1) whether management's representations are accurate and (2) whether or not the company is correctly applying generally accepted accounting principles (GAAP).

Non-assurance services

Fraud investigations

What is the main role of the BOD?

Hire CEO Sets policies for organization, decides how funds should be raised Represent interest of stockholders

What was the SECs response to the collapse of Enron

In 2002, Congress passed the Sarbanes-Oxley Act, officially the "Public Company Accounting Reform and Investor Protection Act of 2002".

Assurance Services

Independent professional services that improve the quality of information, or its context, for decision makers

all of the methods a company uses to safeguard its assets, determine the accuracy and reliability of its accounting information, promote operational efficiency, and encourage employees to adhere to the company's policies.

Internal controls

Role of Internal auditor

These auditors are employed by the company, and they audit departments within the company. While internal auditors are not independent of the company, they typically report directly to top management as well as the audit committee, which is a subcommittee of the company's Board of Directors. Because internal auditors have a voice with both top management and the audit committee, they have considerable power in the company.

What are some qualifications of external auditors

These auditors are qualified CPAs (Certified Public Accountants) who are not affiliated with the company being audited. The "independent" component of the external auditors is important because the public needs assurance that the auditors are separate and apart from management and do not have a vested interest in the outcome of the audit.