Audit exam #4

Operational audits

•Comprehensive examination of an operating unit or a complete organization to evaluate its systems, controls and performance as measured by management's objectives •Purchasing •Data processing •Receiving •Shipping •Office services •Advertising •Engineering

Designing Compliance Procedures

•Concerned with compliance with laws and regulations that could have direct and material effect on each major federal financial assistance program •Assess inherent risk and control risk, then design substantive procedures using OMB Circular A-133 compliance supplement

Vendor Statement

sent monthly by the vendor to indicate the beginning balance, current period purchases and payments, and ending balance

Long-term debt

Substantial in amount and often extend for periods of 20 years or more Examples: Debentures, secured bonds, and notes payable Formal document creating bond indebtedness is indenture or trust indenture May contain restrictive covenants

Compliance auditing

Testing and reporting on whether an organization has complied with the requirements of various laws, regulations and agreements •Statements on Standards for Attestation Engagements provides guidance for examination or agreed-upon procedures but prohibits reviews

Most difficult type of fraud to detect is one based on the

non recording of transactions.

Familiarization

obtain comprehensive knowledge of operating unit -objectives -organizational structure -operating characterstics

Misstatements of liabilities commonly comes from

omission of transactions

Nature of integrated audit

•Auditors of large public companies should report on: •Financial statements, and •Internal control over financial reporting •Based on provisions of PCAOB Standard No. 5, the audits of internal control and financial reporting should be integrated

Identify laws and regulations

(1) discussing laws and regulations with management, program and grant administrators, and government auditors;(2) reviewing state and federal compliance requirement documents; (3) reviewing relevant grant and loan agreements; and (4) reviewing minutes of the legislative body of the governmental organization. •Also obtain written representations from management about completeness of laws and regulations

Single audit act requirements include determine and reporting on:

(1) the financial statements are presented fairly in all material respects in accordance with generally accepted accounting principles, (2) the schedule of expenditures of federal awards is fairly presented in all material respects in relation to the financial statements taken as a whole, and (3) the entity complied with the provisionsof laws, regulations, and contracts or grants that may have a direct and material effect on each major federal financial assistance program.

Professional standards of internal auditors

-1000 Purpose, authority and responsibility -1100 Independence and objectivity -1200 Proficiency and due professional care -1300 Quality assurance and improvement program

Follow up

-Deficiency status -Brief reexamination

Program development

-Planned tests/analysis -Personnel -Schedule

Fieldwork

-collecting evidence -analyze evidence against criteria -findings -document in working papers

Preliminary survey

-critical areas -potential problem areas

Top-down approach figure

1. Financial statements 2. Significant accounts and disclosures 3. Relevant assertions 4. Major classes of transactions and significant processes

Stages of an Audit

1. Plan the audit 2. Obtain understanding of client 3. Assess the risks of MM and design further audit procedures 4. Perform further audit procedures 5. Complete the audit 6. Form an opinion and issue the audit report.

Types of reports with modified opinions

1. Qualified opinion 2. Adverse opinion 3. Disclaimer of opinion

Ethics for GAGAS Audits

1. The public interest—Observing integrity, objectivity, and independence in performing professional services assists the auditors in serving the public interest. 2. Integrity—Public confidence in government is maintained by auditors' performing professional services with integrity. 3. Objectivity—Objectivity includes being independent in fact and appearance when providing audit and attest services, maintaining an attitude of impartiality, being intellectually honest, and being free from conflicts of interest. Similar to AICPA the Yellow Book contains a conceptual framework for independence. 4. Proper use of government information, resources, and position—These items should be used for official purposes and not for the auditors' personal gain or otherwise inappropriately. 5. Professional behavior—Auditors should comply with laws and regulations and avoid any conduct that might bring discredit to the auditors' work.

Disclaimer of Opinion

A disclaimer of opinion states that due to a significant scope limitation, the auditors were unable to form an opinion or did not form an opinion on the financial statements.

A qualified opinion

A qualified opinion states that the financial statements are presented fairly in conformity with generally accepted accounting principles "except for" the effects of some matter.

Reconcile shares outstanding with general ledger

Accounting for stock certificate numbers Examining canceled certificates Reconciling the stockholders ledger and stock certificate book with the general ledger

Financing cycle

Activities of company designed to obtain capital funds Involves issuance and repayment of debt and equity Payment of interest and dividends Primary concern Proper authorization by appropriate official in the company or by board of directors

An adverse opinion

An adverse opinion states that the financial statements are not presented fairly in conformity with generally accepted accounting principles.

debt covenant

An agreement between a borrower and a lender that requires that certain minimum financial measures be met or the lender can recall the debt

Partnership contract

Auditor verifies distribution of net income in accordance with profit-sharing provisions Maintenance of partners' capital accounts at prescribed levels Drawings Loan accounts for partners

Internal control over interest bearing debt

Authorization by the board of directors Use of an independent trustee Interest Payments on Bonds and Notes Payable--Cash disbursement controls Questions Are amounts of new debt authorized by appropriate management? Is an independent trustee used for all bond issues? Does a company official monitor compliance with debt provisions?

Search for unrecorded A/P

Be alert during reconciliations, confirmations and analytical procedures for unrecorded liabilities Examine transactions recorded following year-end Compare cash payments after year-end to accounts payable trial balance Examine cash disbursements over specific dollar amounts during subsequent period

Confirm interest-bearing debt

Confirmed by financial institution Included with standard confirmation form for cash For others, use letter drafted on client's letterhead Confirm dates of origin, due dates, unpaid balances of notes, interest rates, dates to which interest has been paid, and collateral for notes Confirm bonds with trustee

For capital stock small companies use

Control achieved by segregation of duties of authorization of transactions, custody of stock certificates, and recordkeeping Stock certificate book Stockholders' ledger

Audit documentation for long term debt

Copy of loan agreement or indenture related to bond placed in permanent file Extract list of restrictions placed on company for auditor to test compliance Current workpapers Analyses of ledger accounts for notes and bonds payable Related accounts of interest and discount or premium

Sources of owner equity

Corporate accounts Capital stock accounts Preferred and common Retained earnings Prior period adjustments Transactions generally few in number but material in amount

Long term debt risks of material misstatement

Debt covenants Covenants either Require certain financial performance measures to meet a minimum (or maximum) threshold Disallow certain firm actions (e.g., taking on more senior debt) Violation causes the debt to be payable on demand Reclassification of debt to current Possible Going Concern Misclassification of debt (current vs. long-term) Inaccurate amortization of interest & principal Non-recognition of debt on the balance sheet

Customer deposits

Deposits on returnable containers or to guarantee payment of bills Review procedures followed in accepting and returning deposits Verify list of individual deposits and compare to general ledger account Generally do not confirm

Dividends

Determine the dates and amounts of dividends authorized Verify the amounts paid Determine the amount of any preferred dividends in arrears Review the treatment of unclaimed dividend checks

Mission of internal auditing

Enhance and protect organizational value by providing risk-based and objective assurance, advice, and insight.

form an opinion

Evaluate: 1. The results of their evaluation of the design, 2. The results of tests of the operating effectiveness of controls, 3. Negative results of substantive procedures performed during the financial statement audit, and 4. Any identified control deficiencies.

For capital stock large companies use

Independent registrar and stock transfer agent control issuance of stock Ordinarily use a direct registration system

IIA

Institute of Internal Auditors

The separation of what functions tends to prevent errors and fraud?

Invoice verification and cash disbursement

A/P items needed on working papers

Lead schedule for accounts payable Trial balances of various types of accounts payable Confirmation requests for accounts payable Listing of unrecorded accounts payable

Audit documentation for equity

Lead schedule for equity accounts Analysis of each equity account for the permanent file Stock option plan Permanent file list of shareholders and number of shares

Major programs

Major federal financial assistance programs •Those programs to which the auditor must apply procedures to test for compliance and test the effectiveness of controls •Determined by risk-based approach •Amount of program's expenditures •Type A (larger) and Type B (smaller) •Risk of material noncompliance •Auditor must test programs that in aggregate equal 40% of total federal expenditures

Time of examination

Most effective when performed immediately after the balance sheet date Little value if done before because concern with understatements Some can be done at interim: Accrued property taxes Amounts withheld from employees' pay

Sole proprietorships

Net income Withdrawals Capital investments and additions traced to the cash and asset records Ensure segregation of personal transactions from business

Information for each issue of capital stock

Number of share authorized and issued Par or stated value Dividend rates Call and conversion procedures Stock splits Stock options, if any

Likely sources of misstatements

Once the auditors understand entity-control controls and the flow of transactions, the auditors are in a position to: •Verify points within the company's processes at which a misstatement could arise that could be material; •Identify the controls management has implemented to address these potential misstatements; and •Identify the controls management has implemented to prevent or detect on a timely basis unauthorized acquisition, use, or disposition of the company's assets that could result in a material misstatement.

Internal control over capital stock

Proper authorization of transactions by board of directors and corporate officers Segregation of duties in handling transactions Maintenance of adequate records Board of director control of capital stock transactions

Sales tax payable

Required to collect sales tax imposed by state and local governments Not an expense, just collecting agent Liabilities until remitted Verify liability by reviewing tax return Test reasonableness of amount Test invoices for correct tax charge

Amounts withheld from employees' pay

Risk: Income taxes and other amounts withheld from employees' pay but not remitted as of balance sheet date may not be accurately recorded Possible procedures Trace amounts withheld to payroll summary sheets Test computations of taxes and other amounts withheld and accrued Determine that amounts have been deposited in accordance with law

Definition of purpose

Scope of the audit and reprot -Policies and procedure=> Objectives

Inherent risk of long-term debt

Similar to accounts payable in that understatement of debt is a major potential audit problem Disclosure of debt Auditor must determine whether company has met all significant requirements and restrictions of debt agreement

Unmodified opinion—standard report.

This report may be issued only when the auditors have obtained sufficient appropriate audit evidence to conclude the financial statements are not misstated and there is no need to alter the report for situations 2, 3, or 4 below.

Complete the following for each issue of dividends

Title Par or stated value Dividend rate Conversion and call provisions Number of shares authorized, issued, and in treasury Dividends in arrears Shares reserved for stock options or conversions

Unmodified opinion—with an emphasis-of-matter paragraph.

To emphasize a matter appropriately presented in the financial statements (e.g., a change in accounting principles).

Unmodified opinion—with an other-matter paragraph.

To emphasize a matter other than those presented or disclosed in the financial statements (e.g., other information in documents containing audited financial statements).

Vouch borrowing and repayment transactions

Trace cash received from issuance of notes or bonds to validated copy of bank deposit slip and to bank statement Examine payments and agree to repayment schedule Examine canceled notes for retired notes Trace disposition of any collateral used to secure canceled notes

Potential sources for unrecorded A/P

Unmatched invoices and unbilled receiving reports Vouchers payable entered in the voucher register subsequent to balance sheet date Invoices received after balance sheet date Consignments in which client acts as a consignee

Evaluate compliance with debt provisions

Vouch payments to sinking fund Maintenance of stipulated minimum levels of working capital Examine evidence of insurance of pledged property Compare amounts of management compensation and dividends paid to amounts allowed by agreements

When would a qualified opinion be released?

When there is a material departure from GAAP that is not pervasive.

When would a Adverse opinion be released?

When there is a material departure from GAAp and it is pervasive.

When would a disclaimer of option be released?

When there is not a departure from GAAP, but there is a scope limitation and it is pervasive

Obtain analyses of interest-bearing debt and related accounts

a.Payment or other disposition of notes listed as outstanding in the previous year's audit can be verified b.Propriety of individual debits and credits can be established c.Amount of year-end balance of the account is proved through the step-by-step examination of all changes in the account during the year d.Misstatements may be due to improper reporting of debt, incomplete recording of debt, or improper amortization Examine copies of notes payable and supporting documents

Reconciliation, confirmation and ______ may disclose unrecorded liabilities.

analytical procedures

Control deficiency should be reported to the

appropriate levels of management

When there is an oversight deficiency report it to the

board of directors

Search for unrecorded accounts payable

completeness cutoff

Primary objective of Accounts payable is

completeness; and is generated through external evidence help by client vendors and receiving reports.

Vouch balances payable to selected creditors by inspecting supporting documents

existence, occurence, and obligations. Valuation and accuracy cutoff

Interest-bearing obligations are not

included in accounts payable; they are included as bonds, notes, etc.

Primary concern in audit of liabilities

-Possibility of understatement or omission of liabilities Exaggerates the financial strength of company Conceals fraud as effectively as overstatement of assets Accompanied by understatement of expenses and overstatement of net income

Report the findings

-document work and findings -circulate draft report -complete formal report

Specific requirements

1. Activities allowed or not allowed 2. Allowable costs/cost principles 3. Cash management 4. Eligibility 5. Equipment and real property management 6. Matching, level of effort, earmarking 7. Period of availability of federal funds 8. Procurement and suspension and deparment 9. Program income 10. Reporting 11. Subrecipient monitoring 12. Special tests and provisions

Purpose of internal auditing

An independent, objective assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes.

Timing of examination of long term debt

Small number of transactions End of the year - often wait until after balance sheet date for many procedures Test for unrecorded liabilities cannot usually be done before the balance sheet date Evaluation of compliance with debt provisions Tests of interest expense Investigation of notes paid after year-end

Accrued Liabilities

Sometimes called accrued expenses Examples: Salaries, interest, and rent Accumulate over time and management must make accounting estimate at year-end

Unclaimed wages

Subject to misappropriation Concerned with adequacy of internal control Should not be left for more than a few day Prompt deposit in special bank account Analyze unclaimed wages to determine Credit represents all unclaimed wages after each payroll distribution Debits represent authorized payments

Indications of risks of misstatement with A/P

Subsidiary records not in agreement with general ledger Receiving reports and vouchers used haphazardly Purchase transactions not recorded until payment is made Many accounts payable long past due Risks such as these indicate the need for additional substantive procedures

Unmodified opinion on group financial statements.

When two or more CPA firms are involved in an audit and the group auditor (the firm that performs majority of the work) does not wish to take responsibility for the work of the component auditors.

Audit objectives for the audit of A/P

a.Substantiate the existence of accounts payable and establish the occurrence of purchase transactions b.Establish the completenessof recorded accounts payable c.Verify the cutoff of transactions affecting accounts payable d.Establish the proper valuation of accounts payable and the accuracy of purchase transactions e.Substantiate the client's obligation to pay these liabilities f.Determine that the presentation and disclosure of accounts payable are appropriate

Accounting estimates

are activities involving management's judgments or assumptions, •Examples: determining the allowance for doubtful accounts, estimating warranty reserves, and assessing assets for impairment.

Routine transactions

are for recurring activities, •Examples: sales, purchases, cash receipts and disbursements, and payroll.

Material weakness should be communicated to the

audit committee and management

significant deficiency should be communicated to the

audit committee and management (C-Suite)

Operational audit flowchart

1. Definition of purpose 2. Familiarization 3. Preliminary survey 4. program development 5. Fieldwork 6. Report the findings 7. Follow-up

Reconcole liabilities with creditor's monthly statements

Completeness

Timing of examination of dividends

Few transactions but material in amount Analysis most efficient after close of period More time for first audit then continuing audit client

Retained earnings

First year Analysis covers the entire history of the retained earnings account Credits from income summary Debits from net losses, cash and stock dividends, appropriate reserves Appropriations require specific authorization by board of directors

nonroutine transactions

occur only periodically; they generally are not part of the routine flow of transactions •Examples: transactions such as counting and pricing inventory, calculating depreciation expense, or determining prepaid expenses.

Combined report

•The auditors may also issue a combined report on control over financial reporting and the financial statements. •The reports includes the components of both of the separate reports.

Obtain trial balance of payables an reconcile with the ledgers

valuation and accuracy

Section 404 of SOX

•404(a) - requires annual report filed with SEC to include an internal control report by management •Management acknowledges responsibility for establishing and maintaining adequate internal control •Report provides assessment of internal control effectiveness at end of fiscal year •404(b) - requires CPA firm to audit internal control and express an opinion on effectiveness of internal control. (Required for companies with a capitalization in excess of $75,000,000)

Additional Emphasis of Matter Situations—Auditor Discretionary

•A risk or uncertainty. •Significant related party transactions described in a note to the financial statements. •The company is a component of a larger business enterprise. •Unusually important significant events. •Accounting matters affecting comparability (other than changes in accounting principles) of financial statements with those of the preceding year.

Management's Responsibility

•Accept responsibility for effectiveness •Evaluate the effectiveness using suitable criteria •Support the evaluation with sufficient evidence •Provide a report on internal control

Additional Requirements for GAGAS Audits

•Additional requirements •Ethics •Audit communications •Considering the results of previous audits •Noncompliance with provisions of contracts and grant agreements •Audit documentation •Reporting

Audit documentation for GAGAS Audits

•Additional requirements beyond GAAS •Before the report is issued, evidence of supervisory review of the work performed that supports findings, conclusions, and recommendations contained in the audit report. •Any departures from Generally Accepted Government Auditing Standards and the impact on the audit or the auditors' conclusions.

Significant accounts and disclosures

•An account is significant if there is a reasonable possibility that it could contain a misstatement that individually or in aggregate has a material effect on financial statements •Factors •Size and composition. •Susceptibility of loss due to errors or fraud. •Volume of activity, complexity, and homogeneity of individual transactions. •Nature of the account. •Accounting and reporting complexity. •Exposure to losses. •Possibility of significant contingent liabilities. •Existence of related party transactions. •Changes from the prior period.

Attesting to compliance with laws and regulations

•Applying Agreed-Upon Procedures to Specified Requirements •Applying Agreed-Upon Procedures to the Effectiveness of Internal Controls •Performing Examinations

Disclaimer of opinion

•Auditor has no opinion •Issued whenever the auditor is unable to form an opinion as to fairness of financial statements •Circumstances resulting in a disclaimer are those in which the possible misstatements are material and pervasive. •Multiple uncertainties may also lead to a disclaimer •Not an alternative to adverse opinion

Consistency in application of Accounting principles

•Auditors are required to indicate in the report when a company has changed accounting principles resulting in a material effect on the financial statements being reported on •This requirement pertains to changes in accounting principles but not changes in accounting estimates

Certified Internal Auditor (CIA)

•Awarded by IIA •Certification requirements •Bachelor's degree •Pass 6.5 hour exam that consists of: •Essentials of internal auditing •Practice of internal auditing •Business knowledge for internal auditing •Two years work experience in internal auditing or advanced degree with one year of experience

Other communication requirements

•Communicate in writing to management •All control deficiencies regardless of severity •To audit committee •Material weaknesses, significant deficiencies and that all other deficiencies have been communicated to management •To board of directors •If conclude oversight of financial reporting and internal control is ineffective

Audits in accordance with GAAS

•Design audits to obtain reasonable assurance of detecting material misstatements resulting from violations of laws and regulations with a direct and material effect on line-item amounts in the financial statements •Laws and regulations often dictate ways funds are spent •Financial assistance subject to compliance provisions

Auditor's consideration of internal control

•Difference between audit of internal control and audit of financial statements •Time period •Audit of internal control - as of date •Audit of financial statements - entire financial statement period •Differences between small and large clients •Degree of complexity of operations

Compliance report

•Examination report modified when: 1. Material noncompliance with specified requirements. 2. Scope restriction. 3. Involvement of another CPA firm in the examination.

control deficiencies

•Exists when the design or operation of a control does not allow management or employees, in the normal course of performing their functions, to prevent or detect misstatements on a timely basis

Adverse opinon

•Financial statements do not present fairly the financial position, results of operations, and cash flows of client in conformity with GAAP •Material and pervasive departures from GAAP •Auditor believes departure causes financial statements taken as a whole to be misleading

Reports on the financial statements ordinarily include an opinion that is on both the:

•Financial statements themselves: •Balance sheet •Income statement •Statement of cash flows •Statement of retained earnings (equity) •Financial statement disclosures •The notes to the financial statements are considered an integral part of the financial statements

Effect of Substantive Procedures on Audit of Internal Control

•Findings from substantive procedures may affect audit of internal control •Could provide evidence of effectiveness or ineffectiveness of internal control over financial reporting •Example: Identification of material misstatement in financial statements is indicative of at least a significant deficiency in internal control

Reports to SEC

•Forms filed with SEC which include audited financial statements •Forms S1 through S11 (registration statements) •Forms SB1 and SB2 (registration for small businesses) •Form 8K (current report) •Form 10Q (quarterly report) •Form 10K (annual report) •Auditors should be well versed on requirements of each form

Audits in Accordance with Government Auditing Standards (GAGAS)

•GAO issues Generally Accepted Government Auditing Standards (GAGAS) •Use in auditing federal entities and organizations that received federal financial assistance •Included in publication entitled Government Auditing Standards (Yellow Book) •Standards apply only when required by law, regulation, or agreement

Top-down approach

•Goal is to focus on testing those controls that are most important to auditor's conclusion on internal control, avoiding those that are less important •Starts at top •Entity-level controls - those in control environment or monitoring components of internal control •Emphasize those relating to audit committee effectiveness, fraud, and period-end process •Direct or indirect effect

Departure from GAAP

•Immaterial - unmodified •Material - qualified •Material and pervasive—Adverse

Qualified Opinion-Lack of Sufficient Appropriate Audit Evidence (Scope Limitations)

•Imposed by circumstances •Important accounting records destroyed •Due to nature of audit •Engaged too late in year to observe client's beginning inventory •Imposed by client• Client refused to allow auditors to send confirmations to customers •Often results in a disclaimer as opposed to a qualification

Auditors' Standard Report - Public Clients

•Includes the words "Registered" and "Independent" in the title. •Must be addressed to shareholders and board of directors (additional parties are allowable). •References auditing standards of the PCAOB. •Provides a discussion of auditor and management responsibilities. •Includes a paragraph indicating that the auditors have also issued a report on the client's internal control over financial reporting, or is a combined report on both the financial statements and internal control. •Includes a Critical Audit Matters Section.•Includes statement on year audit firm began serving the client. •Signed with name of CPA firm not individual partner •Includes the City of the office with responsibility for the audit •Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion

Reporting for GAGAS Audits

•Independent auditor's report on financial statements •Written report on compliance with laws and regulations and on internal control •Describes scope of tests and present findings •Separate reports are allowed but reference to other report must be made in final paragraph

Communicate with component auditors

•Inform component auditors how their work will be used. •Communicate ethical requirements. •Provide list of related parties. •Communicate significant risks of misstatement.

Effects of Internal Control Testing on Audit Substantive Procedures

•Integrated audit requires tests of controls for all major account and relevant assertions •Will lead to decreased scope of substantive procedures •However, significant deficiencies or material weaknesses could lead to more substantive procedures •Not acceptable to omit substantive procedures completely

Different opinons on different statements

•It is acceptable to express an unqualified opinion on one statement while expressing a qualified or adverse on the others •Example: Auditors retained after client has taken its beginning inventory. A disclaimer may be issued on the income statement (the auditor doesn't know if income is reasonably stated), but an unqualified opinion may be issued on the yearend balance sheet.

Levels of severity of control deficiencies

•Less than a significant deficiency •Significant deficiency - less severe than material weakness yet important enough to merit attention •Material weakness - reasonable possibility that a material misstatement will not be prevented or detected

Management assessment of internal control

•Management can be assisted by consultants but not by the CPA firm that conducts the audit of financial statements •Must understand definition of internal control adopted by the SEC •Evaluation must use an accepted "control framework"such as Internal Control-Integrated Framework created by COSO •Must understand concepts of control deficiency, significant deficiency, and material weakness

Going Concern requirements

•Management must evaluate whether there is substantial doubt about the company's ability to continue in existence for a reasonable period of time (a year from the date of issuance of the financial statement) •Auditor not required to perform procedures specifically designed to test goingconcern assumption but must evaluate the assumption

Test of operating effectiveness of controls

•Nature •Inquiries, inspections, observations, and reperformance •Vary the tests when possible (make them unpredictable) •Timing •Sufficient period of time •Periodic controls - may have to wait to after report date •Extent •Depend on frequency of control

Major Developments Affecting the Internal Auditing Profession

•Need for additional assurance about financial information •Demand by stock exchanges and SEC for management to assume more responsibility for controls and financial information •Need for assurance about the reliability of operational reports •Demand for solutions to operational problems •Passage of the Foreign Corrupt Practices Act of 1977 •Report of the National Commission on Fraudulent Financial Reporting •Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees (1999) •Passage of the Sarbanes-Oxley Act of 2002

Conditions indicative of going concern problem

•Negative cash flows from operations •Defaults on loan agreements •Adverse financial ratios •Work stoppages •Legal proceedings •Loss of a key franchise, customer, or supplier •An uninsured catastrophe •Dividend arrearages

Misstatements become pervasive when any one of the following applies:

•Not confined to specific accounts. •If confined, they represent a substantial proportion of the financial statements. •In relation to disclosures, they are fundamental to users' understanding of the financial statements.

Selecting Controls

•Not necessary to perform tests of all controls •Redundant controls •Do not need to test if duplicate control is tested •Design tests for preventive and/or detective controls •Complementary controls •Both should be tested

Auditors objective

•Plan and perform the audit to obtain reasonable assurance about whether material weaknesses exist to express an opinion on company's internal control over financial reporting •The evidence is gathered for an opinion as of the date specified in management's assessment - normally the last day of the company's fiscal year

Objective of Management's Evaluation of Internal Control

•Provide a reasonable basis for its annual assessment •Process •Evaluate design effectiveness of controls •Evaluate operating effectiveness of internal control •Document the process •Issue the report

Audit report

•Providing an independent and expert opinion on the fairness of financial statements through an audit is the most frequent attestation service •When performing an audit, the auditors gather evidence to obtain reasonable assurance that the statements are in conformity with GAAP

Reporting on Comparative Financial Statements

•Report should cover current year as well as prior period audited by their firm. •Can express different opinions on different years. •Auditor should update report for all prior periods presented for comparison. •If prior period audited by another (predecessor) CPA firm •Current year opinion only covers years the CPA firm audited. •For financial statements audited by predecessor auditor either: •Predecessor auditor reissues report with original date, or •Current auditor refers to report of other auditor.

Reporting on corrected weakness

•Reporting on Whether a Previously Reported Material Weakness Continues to Exist •Management believes material weakness has been eliminated •Auditor engaged to report on whether material weakness continues to exist •Engagement focused on evidence regarding material weakness

Sarbanes-Oxley Compliance

•Skills and experience make internal auditors valuable to compliance effort •Involvement •Document and test controls to support management's assertion •Role can be significant but it is management's responsibility to ensure organizational compliance •Role should not impair objectivity •External auditors can rely on work of internal auditors to fulfill responsibilities

Management's Report on Internal Control

•State that it is management's responsibility to establish and maintain adequate internal control. •Identify management's framework for evaluating internal control. •Include management's assessment of the effectiveness of the company's internal control over financial reporting as of the end of the most recent fiscal period, including a statement as to whether internal control over financial reporting is effective. •If, applicable, include a statement that the company's auditors have issued an attestation report on management's assessment.

Single Audit Act

•Statutory requirement to test controls over compliance and compliance with program requirements •Applies to states, local governments, and nonprofit organizations that expend $750,000 or more within a fiscal year in federal financial assistance •Audits are more extensive

Components of internal control (COSO)

•The Control Environment •Risk Assessment •Control Activities •Information System Relevant to Financial Reporting and Communication •Monitoring Activities

In accepting the change in accounting principles, the auditors should evaluate whether

•The newly adopted principle is generally accepted •The method of accounting for the effect of the change is in conformity with generally accepted accounting principles •The disclosures related to the change are adequate •Management has justified that the new accounting principle is preferable.

Auditors' Standard Report - Nonpublic Clients

•Title that includes the word independent •Ordinarily addressed to the company itself, the shareholders, the audit committee, and/or the board of directors •Signed with name of CPA firm not individual partner unless the firm is a sole practitioner •Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion

Performing Walk-Throughs

•Tracing a transaction from its origination through the company's information system until it is reflected in the company's financial reports •Provide evidence to: •Verify that the auditors have identified points at which a significant risk of misstatement to a relevant assertion exists. •Verify their understanding of the design of controls, including those related to the prevention or detection of fraud. •Evaluate the effectiveness of the design of controls. •Confirm whether controls have been placed in operation (implemented).

Group engagement team should obtain understanding of

•Whether component auditors are competent and understand and will comply with ethical requirements. •Extent of group engagement team involvement with component auditors. •Whether group engagement team will be able to obtain necessary information on the consolidation process. •Whether component auditors operate in a regulatory environment that actively oversees auditors.