acct 5200 exam 1

key position

-an individual at a client who has primary responsibility for significant accounting functions and/or preparation of F/S -ability to exercise influence over contents of F/S: director, CFO, CEO, CAO, COO, president, general counsel, controller, director of internal audit or financial reporting, treasurer or equivalent

general auditing standards

-auditor is ONLY responsible for the audit, NOT financial statements -independence -adequate technical training and proficiency -due professional care (have a questioning mind) provide reasonable assurance that F/S are free from material misstatement

individual in position to influence attest engagement

-evaluates performance or recommends compensation of engagement partner -directly supervises/manages engagement partner (ALL the successively senior people in the firm) -consults with (advises) engagement team technical/industry related matter -participates in quality control activities

balance-related audit objectives

-existence -completeness -rights and obligations and then the mgmt assertion of valuation and allocation breaks down into these audit objectives: -accuracy -classification -cutoff -detail tie in -realizable value

covered member

-individuals on the attest engagement team (audit team) -an individual in a position to influence the attest engagement (consultants) -a partner or manager who provides non attest services to the attest client once s/he provides 10 hours of non attest services (ie tax consultants) -all partners in the office in which the lead attest engagement partner primarily practices in connection w the attest engagement -the firm, including the firm's employee benefit plan -an entity whose operating, financial or accounting policies can be controlled by any of the individuals or entities described above or by two or more such individuals or entities if they act together

professional skepticism (2 components)

-questioning mind -critical assessment of audit evidence

reduce information risk (3 ways)

-user verifies information (may be too costly) -user shares information risk: management is responsible for providing reliable information to others, users= potential for financial losses ex: you and company agree to balance risk premium out between you two, this leads to issues bc if something goes wrong there will be a lawsuit -provide audited financial statements: most common way to reduce information risk

steps to develop audit objectives

1. understand objectives and responsibilities of the audit 2. divide financial statements into cycles 3. know management assertions about financial statements 4. know general audit objectives for classes of transactions, accounts and disclosures 5. know specific audit objectives for classes of transactions, accounts and disclosures

audit evidence decision process

1. what audit procedures to use (by asking what could go wrong for each auditor objective) 2. what sample size to select for each procedure 3. which items to select from the population 4. when to perform the procedures (timing)

Siemens example

1.4B from 2001-2007, hired 2700 consultants annual bribery budget $40-50million for Siekaczek's division paid $4m to Argentinian government ro win $1b contract got caught, Siekaczek said it was the consultant, not him fined 1.6b for bribing

independence

2 rules: independence in mind (fact) and independence in appearance (reasonable investor rule)

AICPA code of professional conduct

6 principals: -responsibilities -the public interest -integrity -objectivity and independence -due care -scope and nature of services rules: -the most prominent rule is the independence rule

AICPA/ASB

AICPA auditing standards, applicable to private company audits standards very similar to PCAOB, slight differences

Walmart example

Walmart wanted to build a store 1 mile from ancient pyramids new zoning laws prohibited. walmart realized that zoning changes are only made official if published in government newspaper bribed government employee $84000 to change map to allow zoning Walmart US shut down widespread internal investigations eventually media got ahold of it and only then walmart took action

ethics

a set of moral principles or values personal and professional CPAs as professionals have a responsibility to the public, client and fellow practitioners CPAs need to instill public confidence in the profession

accuracy

concern is whether recorded transactions are stated at the correct amounts (IS) ie does price * quantity = amt billed; does quantity billed - quantity shipped (there's a distinct difference between accuracy and completeness/occurence- if it hasn't occurred/been recorded, then there can't be an accuracy problem) so step 1- did it occur? was it recorded? if yes, then step 2- was it done so accurately?

existence

concern is whether what is recorded should actually be recorded recorded balance sheet balances are for real assets and liabilities on the BS date here we're concerned with the OVERSTATEMENT of accounts (usually assets)

occurence

concern is whether what is recorded should actually be recorded recorded income statement transactions happened during the accounting period here we're concerned with the OVERSTATEMENT of accounts (usually revenue)

Sarbanes Oxley Act of 2002 (SOX)

create and empowered the Public Company Accounting Oversight Board (PCAOB) SEC restrictions, specifically regarding independence and non-audits services required mandatory partner rotation and integrated audits partner rotation- partners can only work on a client for 5 years. disadvantage here is that new partners have to learn the industry and the client relationship partners- role companies have created where these partners don't touch the audit or F/S, they just deal w the client, make sure they're happy

Dodd Frank Wall Street Reform and Consumer Protection Act

created restrictions for financial services companies

financial statement audit

designed to provide reasonable assurance that financial statements are free of material misstatements

detail tie in

details in account balances agree w master file

compliance audit

determines whether the audit is following specific procedures, rules or regulation set by some higher authority

fraud facts

employee fraud more common than management fraud (60% of companies experience EF, 7% experience mgmt) mgmt fraud is more expensive than employee fraud (average EF= $464k, average mgmt= $258M) estimates of $2.92b in fraud annually in USA there's no such thing as immateriality with fraud; the act of fraud is always material

operational audit

evaluates efficiency and effectiveness of any part of organization's operating procedures and methods

analytical procedures

evaluation of financial information through analysis of plausible relationships among financial and nonfinancial data REQUIRED during planning and completion phases of the audit CAN BE used as an audit procedure during fieldwork during planning this helps us understand changes in the clients business from the past year and identify trends or specific events that we need to consider during audit planning during completion this can help assess going concern issues; does the company have any unusual changes or ratios that could indicate a concern? can be used to test account balances, use depends on significance of the account, predictability of the relationship and reliability of underlying data

mutual or conflicting interest with audit client

ex: owning shares, family relationships, romantic relationships

management assertions

expressed or implied representations by management regarding the recognition, measurement, presentation and disclosure of information in the financial statements (about classes of transactions and the related accounts in the FS) the auditors purpose is to test whether management's assertions are true

ethical challenges/dilemmas

greater and more aggressive competition investor demands (higher returns, quick profits and consistent quarterly earnings) executive salaries globalization of business (bribery, kickbacks, fair labor standards- standards aren't the same everywhere as they are in USA. do you conform in new markets or keep USA ethical standards?) rationalizations are that everyone does it, if it's legal, it's ethical, or likelihood of discovery and consequences. low chance of getting caught, high bonus=worth the risk

audit his/her own work

help client do their bookkeeping and then audit can- can advise but there is a fine line

function as management/employee of audit client

if on the inside, it is difficult to maintain objectivity and not be influenced while auditing

close relative

immediate family plus a parent, sibling or non dependent child; covered members but not as stringent rules

reasonable investor rule

independence is violated if in light of all the relevant facts and circumstances, a reasonable investor would conclude that the auditor would not be capable of acting without bias

assurance

independent professional service that improves the quality of information for decision makers anything that improves quality and doesn't have to be CPA; anyone can provide these services ex: consumer reports, better business bureau, corporate social responsibility and sustainability reports

attest engagement team

individuals from audit, tax, consulting, and clerical participating in the attest engagement including those performing concurring and 2nd partner reviews

biases and motives of the provider

information could be biased if provided by someone whose goals are inconsistent w those of the decision maker can be because management is conservative or aggressive, has subconscious bias, etc.

IAASB

international standards on auditing, applicable to entities outside the US international version for international based companies

act as an advocate for audit client

it is not the auditor's job to try to make client the best in the industry/be invested in it's success

persuasiveness of evidence

key is that the evidence is *sufficient appropriate evidence to support the opinion issued* it is unlikely that an auditor will be completely convinced that the opinion is correct bc of: -nature of evidence -cost consideration so essentially we balance how much evidence to gather/how to gather it vs. the cost auditor must be persuaded that opinion is correct two determinants of persuasiveness of evidence: 1. appropriateness 2. sufficiency persuasiveness of evidence can be evaluated only after considering BOTH appropriateness and sufficiency

misappropriation of assets

low level employees stealing assets from company. not intending to manipulate FS report to management, determine why it happened/where weakness areas were that allowed it to happen

internal controls over financial reporting (ICFR) audit

management assets that internal controls have been developed and implemented and the auditor attests to the effectiveness of internal controls

material vs immaterial

material- what influences a reasonable investor; no set number, it varies by company immaterial- everything below material threshold

appropriateness of evidence

measure of the quality of evidence the degree to which evidence is considered believable/worthy of trust deals only w audit procedures selected cannot be improved by selecting a large sample size or different population items (here we're concerned w the quality of evidence, not size)

contingent fees

members in public practices shall not: -perform any professional services for a contingent fee for whom the member or member's firm perform -prepare an original or amended tax return for a contingent fee contingent fees okay for non attest services, unless firm is also performing attestation services cannot structure payments/fees on contingent basis because the influences outcomes and biases, services must be set price, outcome cannot be influenced

attestation

more specific type of assurance service; a CPA is engaged to issue a *written* communication that expresses a conclusion about the reliability of a *written* assertion that is the responsibility of another party services that improve quality of information and come w a WRITTEN report ex: financial statements audits, financial statement reviews, attestation over internal control over financial reporting, other attest services like SOC reports

complexity

not everyone has accounting/finance background=hard for users to understand exchanges are more and more complex and therefore difficult to record

inquiry

obtaining written or oral information from the client in response to questions from the auditor inquiry cannot be regarded as conclusive bc it's not from an independent source and may be biased in the clients' favor evidence obtained through inquiry needs further corroborating evidence

Transaction-related audit objectives

occurence completeness accuracy posting and summarization classification timing

direct financial interest

ownership of stock or other equity shares and debt securities by members or their immediate family two rules: covered persons and their immediate families prohibited from ANY direct investments in clients direct investments of >5% of equity of audit client/affiliates prohibited by all audit firm professionals , their immediate family and close relatives

types of audit evidence

physical examination confirmation inspection analytical procedures inquiries of the client recalculation reperformance obeservation

accuracy (audit objective)

prices, quantities and math are correct in balance sheet accounts

monitoring

principal agent model- motivating someone to work hard all the time shard to do, have to prepare and adjust for this by monitoring and making incentive adjustments audits are done to reassure shareholders so they will be willing to pay management more

sufficiency of evidence

quantity of evidence determines its sufficiency measured primarily by sample size selected as sample size increases, sufficiency increases certain qualitative factors also impact sufficiency; ie does the sample represent the population

professional skepticism (6 common characteristics)

questioning mindset: a sense of doubt suspension of judgment: withholding a judgment until appropriate evidence is obtained search for knowledge: desire to investigate beyond the obvious, a need for corroboration interpersonal understanding: awareness of the potential motives and biases of others autonomy: a drive to decide for oneself self-esteem: self-confidence to challenge assumptions

recalculation

rechecking a sample of computations includes rechecking arithmetical accuracy (footing and cross-footing) and checking computation methods so it checks accuracy AND posting & summarization accuracy= checking the math; p&s= checking sub ledger matches the GL

two characteristics of appropriate evidence

relevance: evidence must pertain to the audit objective that the auditor is testing before it can be reliable -ex: looking at recorded sales for shipments actually made- would relevant evidence be sales invoice or shipping documents? reliability: degree to which evidence is believable or trustworthy -independence of provider -effectiveness of client's internal controls -auditor's direct knowledge -qualifications of individuals providing the information -degree of objectivity -timeliness

timing

same concept as cutoff- ensuring appropriate timing of when transactions are recorded so cutoff = mgmt assertion but timing = audit objective

auditing regulation

self-regulated until the early 2000s; resulted in incentives that didnt align w the purpose of an audit, scandals like Enron arose led to creation of the Sarbanes Oxley Act of 2002

4 ways information is improved

signaling, monitoring, information-risk reduction, insurance

immediate family

spouse or equivalent and dependents, considered covered members

determining error vs fraud

step 1- look at intention/motivation . if unintentional, error. if intentional, fraud step 2- f error, find source, address why it is occurs if fraud, then need to figure out the type is it pervasive, is there collision? determine severity figure out if management fraud or misappropriation of assets.

standards of performance

sufficient appropriate evidential matter (evidence) is to be obtained through inspections, observation, inquiries and confirmations to afford a reasonable basis for an opinion regarding the financial statements under audit decisions about the quantities and types of evidence to accumulate is based on professional judgement

3 areas of overall audit objectives

tests of transactions test of account balances related disclosures

audits

the accumulation and evaluation of evidence about information to determine and report on the degree of correspondence between the information and established criteria. Should be done by a competent, independent person a specific type of attestation service financial statement audits, internal controls over financial reporting audits, operational audits

inspection of documents (documentation)

the auditor's examination of the client's documents and records to substantiate the information that is or should be included in the FS can be paper or electronic two classifications: -internal (mgmt generated) -external (3rd party generated) all else being equal, external doc more persuasive

error vs. fraud

the difference is intention error=non intentional fraud=intentional the intention drives auditors reaction to the misstatement

physical examination

the inspection or count of a tangible asset by the auditor persuasiveness is determined by: -first hand completion of a job= fairly persuasive -pulling invoices is less persuasive than counting note- if an object being examined has no inherent value, the evidence is called inspection so no inherent value= documentation inherent value= prefer counting

information risk

the possibility that the information upon which the business risk decision was made was inaccurate causes: -remoteness of information -biases and motives of the provider -complexity -voluminous data cost of information risk is a factor in Cost of Capital; COC= risk free rate of return, economic risk premium, information risk premium higher information risk premium=high cost of capital

confirmation

the receipt of a written or oral response from an independent third party verifying the accuracy of information that was requested by the auditor accts commonly confirmed: cash, investments, accts receivable, cash surrender value of life insurance, loans payable, inventory on consignment or in public warehouse -fairly persuasive bc comes from third party, but must consider reliability of third party key is that verified by an independent third party (ie a bank is more reliable than an everyday customer)

indirect-effect illegal acts (no direct effect illegal acts)

these illegal acts affect the financial statements indirectly (usually relating more to operating aspects than to its financial and accounting aspects-so financial statement effect is indirect) ex: violations of ERPA laws, FDA, OSHA, EEOC there is a financial statement effect only if there is a fine, sanction or contingent liability *auditors provide no assurance that indirect-effect illegal acts will be detected * company is breaking a law/regulation, but it doesn't directly relate to FS. but until a $ amount (fine, etc.) hits FS, it's not auditors responsibility audit opinion only required to include violation if it has FS impact, but usually they will report it anyway

completeness

this is BS and IS concern is whether all transactions and balances that should be recorded are actually recorded here we're concerned with UNDERSTATEMENT of accounts (usually expenses and liabilities)

auditor responsibility (AS 1001)

to plan and perform audit to maintain reasonable assurance about whether FS are free of *material misstatement*, whether caused by error or fraud to obtain *reasonable*, but not absolute assurance that material misstatements are detected to express opinion on FS auditor has NO responsibility to plan/perform audit to obtain reasonable assurance in detection of immaterial error or fraud

posting and summarization

transactions are correctly transferred from journals to subsidiary ledgers to general ledgers (not just accurately calculated, also accurately posted- an additional test/step)

cutoff (audit objective)

transactions near the BS date are recorded in the correct period

management fraud

upper level management engages in fraudulent financial reporting; manipulates FS for their gian report to audit committee, potentially SEC. resign as auditor. company is tainted and you dont want to be associated.

observation

use of the senses to assess certain activities involves looking at a process or procedure being performed by others (physical examination is a subset of observation) observation is rarely sufficient by itself because: -risk that knowledge of being observed changes peoples' behavior (heisenberg effect)

indirect financial interests

when a person owns shares of a client through another entity or has a mutual interest with a client there is a close, but not direct ownership relation between the auditor and the client, ie mutual fund d firm, covered persons and immediate family prohibited from material indirect investment, including owning>5% of entity that owns interest in audit client owning >5% of entity of which audit client owns an interest investments by covered persons and immediate family less than or equal to 5% of a diversified investment company that invests in an audit client is not a violation

voluminous data

with large organizations there are large number of transactions which increases the likelihood that information is recorded improperly also with large amounts of data how is the relevant data chosen? is it being used the right way? management has much more insight and information than what is actually presented. this could lead to a discrepancy between what management knows and what users know

PCAOB

PCAOB auditing standards, applicable to all US public company audits and other SEC registrants similar to AICPA standards general auditing standards- standards on broad auditing principles, concepts, activities and communications audit procedures- standards for planning and performing audit procedures and for obtaining audit evidence auditor reporting- standards for auditors' reports (guidelines for what we're providing)

3 governing bodies

IAASB, AICPA/ASB, PCAOB

valuation and allocation

concern is whether recorded balances are included in the financial statements at correct amounts, including appropriate allowances for valuation (BS)

classification

concern is whether recorded transactions are in the appropriate account (IS) ie expense vs capitalization

cutoff

concern is whether recorded transactions are recorded in the correct accounting period (IS) ensuring everything on the IS really happened within the time period

Four Principles for Independence

CPA (and therefore his/her firm) violates independence when: 1. mutual or conflicting interest with audit client 2. audits his/her own work 3. functions as management or as an employee of the audit client 4. acts as an advocate for the audit client

types of auditors and audit firms

CPA firms- external and independent auditors Government Accountability Office (GAO) auditor- reports to congress; performs a wide variety of audits such as expenditure compliance and operational efficiency and excellence of federal programs IRS tax auditors Internal Auditors- employed by all types of organizations; report to the audit committee, perform a variety of audits such as compliance, operational efficiency and financial statement audits

mortgage backed securities example

banks related mortgage standards, high risk people were able to get mortgages banks bundled these high risk mortgages together and sold them off to investors skewed professional and personal ethics that allowed this to happen and led to huge financial crisis of 2008

direct-effect illegal act (AS 2405.05)

The auditor considers laws and regulations that are generally recognized by auditors to have direct and material effect on the determination of financial statement amounts these illegal acts have a direct financial effect on specific account balances in the financial statements auditor's responsibility for direct-effect illegal acts is the same as for misstatements caused by fraud or error

audit objectives

break management assertions into manageable chucks that allow auditors to test the assertions if auditor has sufficient evidence that audit objective is met, then s/he also has reasonable assurance that the FS are fairly presented management assertions DRIVE the auditor's objective

remoteness of information

can't get an inside view//don't know what's actually happening on the inside because it's being provided by others

rights and obligations

concern is whether all recorded assets are the rights of the entity and all recorded liabilities are the obligation of the entity at a given date (BS date)

management responsibility (AS 1001)

adoption of sound accounting policies establishment and maintenance of internal control system that will initiate, record, process and report transactions consistent w management's assertions fair representation of financial statements ultimately, the responsibility of acct choices, preparation of financial statements and internal controls falls on management, NOT AUDITORS

independence in appearance

aka independence by the Reasonable Investor Rule the avoidance of circumstances that would cause a reasonable and informed third party, who has knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity or professional skepticism of a firm or member of the attest engagement team is compromised

independence in mind

aka independence in fact state of mind that permits a member to perform an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism free from putting yourself in a mindset of bias

evidence

any information used by the auditor to determine whether the information being audited is stated in accordance with GAAP this information varies greatly in the extent to which it *persuades* the auditor whether the FS are stated in accordance with GAAP it must persuade us that FS are accurate; evidence won't give us 100% so we need to identify and determine evidence to persuade us

balance sheet assertions

assertions about account balances -existence -completeness -valuation and allocation -rights and obligations

income statement assertions

assertions about transactions and events -occurence -completeness -accuracy -classification -cutoff

realizable value

assets are carried at amounts that are estimated to be realized. aka estimates are reasonable/accurate

insurance hypothesis

assumption that an audit provides "insurance" in the even that something goes wrong injured parties can be -investors who relied on audited financial statements can sue auditors who are negligent and who have deep pockets -politicians who would be blamed for a company failure; allows SEC to point the finger at auditors and avoid blame when company goes bankrupt, investors will sue company and auditors. but usually blame falls on company

signaling

assurance provides a method of credibility signaling the quality of the commodity to the consumer so higher price can be charged consumers are more willing to pay higher if there is a signal of high quality

reperformance

auditor's independent tests of client accounting procedures and/or controls rechecking transfers of information made by the client during the period under audit includes transfers of information and comparing price used on an invoice to the master price list redoing what a client has done; often used for controls testing

auditors' responsibility for fraud

auditors have a responsibility to obtain reasonable assurance that the FS are free from material misstatements, including material misstatements caused by fraud AS 2401 requires auditors to: -consider the presence of fraud risk factors (fraud triangle) -based on risk factors present, make an assessment of the risk of material misstatement due to fraud -based on that assessment, develop an appropriate response

reasonable vs absolute assurance

auditors will be confident in the audit, but cannot 100% guarantee that the FS are free of material misstatements because they can't look at every single thing with riskier companies, you want higher levels of assurance

classification (audit objective)

balances are in the correct BS accounts ST vs LT debt, trade receivables vs other receivables, etc.