Audit Exam #4
Examples of Routine Transactions
Cash receipts, cash disbursements, payroll, inventory costing (CGS), accounts receivable and sales
Items that do not affect consistency
Changes in accounting estimates (ex: changing the life of a fixed asset) and changes in principles with an immaterial effect (even if the effects are expected to be material in the future)
Purpose of Management Letter
Communicate deficiencies that are less than significant to management when they believe that they deserve management's attention. Serves as a valuable reference document for management and also may serve to minimize the auditors' legal liability in the event of a defalcation or other loss resulting from a weakness in internal control.
Example of analytical procedure that should be applied to the income statement
Compare the actual revenues and expenses with the corresponding figures of the previous year and investigate significant differences
Rollover Approach
Considers only the amount of the misstatement originating in the current year income statement
Iron Curtain Approach
Considers the balance sheet effect of correcting the total misstatement existing at the end of the year, regardless of when the misstatement originated
Examples of Nonroutine Transactions
Financial statement close, LIFO calculation, physical inventory count
Auditor's responsibilities for the detection and evaluation of subsequent events
Generally, the auditors' responsibility for performing procedures to gather evidence as to subsequent events extend only through the date of the audit report. However, even after completing normal audit procedures, the auditors are responsible for evaluating subsequent events that come to their attention prior to the report release date. (p. 644 - 647)
Segregation of Duties within Payroll
Human resources, timekeeping, payroll preparation and record keeping, distribution of pay to employees. For effective internal control, a separate department of the company should handle each of these functions
Purpose of Schedule of Unadjusted Differences
Identify the potential financial statement effects of errors or disputed items that were considered immaterial when discovered.
Type 2 Subsequent Events
Involves conditions that arose after the date of the financial statements. These events do not require adjustment to the dollar amounts shown in the financial statements, but they should be disclosed in the financial statement notes if the statements otherwise would be misleading. (Examples on p. 645)
If 2 years of audited financials are presented together, continuing auditor's report should cover......
the current year's financial statements
Assertions tested in revenue process
occurrence, completeness, accuracy, cutoff, presentation & disclosure
Relationships Between Revenue Accts and Balance Sheet Accts
p. 631
Relationships Between Expense Accts and Balance Sheet Accts
p. 632
Items that do affect consistency
A client's correction of a material misstatement in previously issued financial statements, uncertainties, a major catastrophe that has had, or continues to have, a significant effect on the organization, significant transactions with related parties, and unusually important subsequent events
Material Weakness
A control deficiency, or a combination of control deficiencies, in internal control over financial reporting, such that there is reasonable possibility that a material misstatement of the company's annual or interim financial statements will not be prevented or detected on a timely basis
Significant Deficiency
A deficiency, or a combination of deficiencies, in internal control over financial reporting that is less severe than a material weakness, yet important enough to merit attention by those responsible for oversight of the company's financial reporting
Type of report issued if material weakness exists
A material weakness in internal control that exists at year-end results in the issuance of an adverse report. When expressing an adverse opinion, the auditor's report must define a material weakness, indicate that one has been identified, and refer to the description of it in management's report
Qualified Opinion
A modification of the auditors' standard report, employing a clause such as "except for" to limit the auditors' opinion on the financial statements. A qualified opinion indicates that, except for the effects of some limitation on the scope of the audit or some departure from generally accepted accounting principles, the financial statements are fairly presented (p. 676 tells when to issue this opinion)
Representation Letter
A single letter or separate letters prepared by officers of the client company (management) at the auditors' request setting forth certain representations about the company's financial position or operations. Primary purpose is to have the client's principal officers acknowledge that they are primarily responsible for the fairness of the financial statements. It should be dated as of the date of the audit report. They are part of the audit evidence the auditors obtain, but they are not a substitute for the application of other necessary audit procedures.
Deficiencies in Internal Controls
A weakness in the design or operation of a control that does not allow management or employees, in the normal course of performing their functions, to prevent or detect misstatements on a timely basis
Remediation of material weaknesses and effects upon audit opinion on effectiveness of ICFR
After a client has remediated a material weakness that led to an adverse report, auditors may be engaged to attest to the elimination of the material weakness. If management corrects this weakness prior to year-end, teh auditors can issue an unqualified opinion if the auditors have sufficient evidence to provide reasonable assurance that the new control is operating effectively
Auditor's required communication with management
All control deficiencies in internal control identified during the audit, significant deficiencies and material weaknesses identified in an audit, Whenever the auditor has determined that there is evidence that fraud may exist, that matter should be brought to the attention of an appropriate level of management. identified misstatements
COSO Framework (internal control)
Although not required, the control framework ordinarily used is the Internal Control-Integrated Framework, created by the Committee of Sponsoring Organizations of the Tread-way Commission (COSO). The COSO framework (revised in 2013) is the internal control framework commonly used in audits of financial statements
Type of report issued if a deficiency in internal controls exists
An adverse report
Integrated Audit (under PCAOB Standard No. 5
An audit that includes audit reports on both a company's internal control over financial reporting and the financial statements
Unmodified Opinion with Emphasis-of-Matter Paragraph
An emphasis-of-matter paragraph in an audit report follows the opinion paragraph and is included to refer to a matter that is appropriately presented or disclosed in the financial statements but is being emphasized through the audit report. IN certain circumstances, an emphasis-of-matter paragraph is required (e.g., when there is substantial doubt about a company's ability to continue as a going concern and when the company changes accounting principles). In others, it is included at the auditor's discretion (e.g., an uncertainty relating to future exceptional litigation, significant transactions with related parties, or unusually important subsequent events) (circumstances on p. 676 - 677)
Projected Misstatements
An estimate of the most likely amount of monetary misstatement in a population
Type of report issued if a significant deficiency exists
An unmodified report
Situations that would cause modification of auditor's report due to scope limitation
Audit evidence should be available and is not - due to circumstances beyond the control of the organization (ex: important accounting records were destroyed), circumstances dealing with the timing of the auditors' work (ex: the auditors are hired too late to observe the client's beginning inventory), or limitations imposed by client/management (ex: the client's refusal to allow the auditors to send confirmations to customers)
When Analytical Procedures are required to be performed
Auditing standards require the application of analytical procedures at the risk assessment stage and near the end of the audit. During the risk assessment stage, auditors are required to perform analytical procedures relating to revenue to identify any unusual our unexpected relationships involving revenue accounts that may be indicative of fraud. They should be used near the end of the audit to assist the auditor in forming an overall conclusion on financial statements and in assessing the adequacy of the evidence that has been collected and the validity of the conclusions reached. While the auditors are not required to use substantive analytical procedures, they are usually the most efficient test of certain assertions.
Component Auditors
Auditors that audit one or more components of a group of entities that provide consolidated financial statements. In the PCAOB standards, component auditors are referred to as other auditors
Examples of Estimate Transactions
Estimate purchase commitments, estimate excess and obsolete inventory, and lower-of-cost-or-market calculation
Steps involved in evaluating auditing findings
Evaluation Materiality - Considering Quantitative Factors, Evaluation Materiality - Considering Qualitative Factors, Evaluation Materiality - Considering the Effects of Prior Year Uncorrected Misstatements, Evaluating the Risks of Material Misstatement, Review the Financial Statement Disclosures, Client Approval of Adjusting Entries and Disclosures (p. 648 - 652)
Dual Dated Report
Example: "Dual-date their report February 3, except for Note X, as to which the date is February 11." Dual-dating extends the auditors' responsibility for disclosure through the later date only with respect to the specified item. Using the later date for the date of the report extends the auditors' responsibility with respect to all areas of the financial statements.
Contingent liabilities' effects on reports
Loss contingencies should be reflected in the accounting records when both of the following conditions are met: (1) Information available prior to the issuance of the financial statements indicates that it is probable that a loss has bee sustained before the balance sheet date, and (2) the amount of the loss can be reasonably estimated. Recognition of the loss may involve either recognition of a liability or reduction of an asset. When a loss contingency has been accrued in the accounts, it is usually desirable to explain the nature of the contingency in a note to the financial statements and to disclose any exposure to loss in excess of the amount accrued. Loss contingencies that do not meet both criteria should still be disclosed in a note to the financial statements when there is at least a reasonable possibility that a loss has been incurred. (p. 641)
Other (Likely) Misstatements
Misstatements identified by the auditors during the course of the audit that are due to either extrapolation from audit evidence or differences in accounting estimates
Disclaimer of Opinion
Most frequently is the result of a scope limitation that creates a situation in which the auditors are unable to obtain sufficient appropriate audit evidence on which to base the opinion, and they conclude that the possible effects on the financial statements of undetected misstatements, if any, could be both material and pervasive. A disclaimer is not an opinion; it simply states that the auditors do not express an opinion on the financial statements (when to issue on p. 676)
When an audit partner reviews working papers
Near the completion of the audit
Purpose of Walk-throughs
Obtain an understanding of the likely sources of misstatement. It provides the auditors with evidence to: (p. 718)
Letter of Inquiry
Primary source of corroborative evidence concerning litigation, claims, and assessments is the client's legal counsel, is good for establishing completeness of potential liabilities and providing factual information about contingencies. attorney responses will be less than forthcoming about the likelihood of unfavorable outcomes, and the estimated amount of any potential losses. An attorney's refusal to provide the requested information is a scope limitation sufficient to preclude issuing an unqualified opinion (p. 641 - 642)
Auditor's responsibility for other information presented with the financial statements (e.g. MD&A)
Read this information for inconsistencies, if any, with the audited financial statements. If no inconsistencies are identified, the auditors are not required to reference the other information in the auditors' report on the financial statements. However, if they so choose, they may include an other-matter paragraph disclaiming an opinion on the other information.
Information that should be disclosed when disclaimer is issued for lack of CPA independence
Reasons for the lack of independence and state that the CPA is not independent
Type 1 Subsequent Events
Requires that the financial statement amounts be adjusted to reflect the changes in estimates resulting from the additional evidence as to conditions that existed at the date of the financial statements (Examples on p. 644 - 645)
Procedures used to identify contingent liabilities
Reviewing minutes of directors' meetings, inquiring of the client's lawyer, reviewing correspondence with financial institutions and regulatory agencies, sending confirmations to financial institutions, and obtaining a representation letter from officers of the company
Known Misstatements
Specific misstatements identified by the auditors during the course of the audit
Adverse Opinion
States that the financial statements are not presented fairly in conformity with generally accepted accounting principles. Auditors issue an adverse opinion when the deficiencies in the financial statements are both material and pervasive. All significant reasons for the issuance of an adverse opinion should be set forth in a basis for modification paragraph that precedes the opinion paragraph
Differences between nonpublic and public company audit reports
The PCAOB report: includes the words "Registered" in the title, references standards of the PCAOB rather than generally accepted auditing standards, includes less detailed discussions of management and auditor responsibilities, includes an additional paragraph indicating that the auditors have also issued a report on the client's internal control over financial reporting, does not include section headings
Unmodified Opinion
The opinion expressed by the auditors when they conclude that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework (e.g., GAAP)
Purpose of Internal Controls Over Payroll
The possibility of large-scale payroll fraud still exists, a great mass of detailed information concerning hours worked and rates of pay must be processed quickly and accurately if workers are to be paid promptly and without error, the existence of various payroll tax and income tax laws that require that certain payroll records be maintained and that payroll data be reported to the employee and to governmental agencies.
Communication between predecessor auditor and successor auditor
The predecessor's response can be limited to stating that no information will be provided. The purpose of the requirement in having communication between the predecessor and successor auditors is to help the successor auditor to evaluate whether to accept the engagement. The predecessor auditor is required to respond to the request of the successor auditor for information, but the response can be limited to stating that no information will be provided when there are actual or potential legal problems between the client and the predecessor. The successor auditor should make specific and reasonable inquiries of the predecessor auditor regarding matters that will assist the successor auditor in determining whether to accept the engagement. The predecessor auditor should respond promptly and fully, on the basis of known facts, to the successor auditor's reasonable inquiries. he predecessor auditor should ordinarily permit the successor auditor to review working papers, including documentation of planning, internal control, audit results, and other matters of continuing accounting and auditing significance, such as the working paper analysis of balance sheet accounts, and those relating to contingencies. Also, the predecessor auditor should reach an understanding with the successor auditor as to the use of the working papers.
Section 404 SOX
The primary section of the Sarbanes-Oxley Act dealing with management and auditor reporting on internal control over financial reporting. Section 404(a) requires that each annual report filed with the Securities an Exchange Commission include an internal control report prepared by management in which management acknowledges its responsibility for establishing and maintaining adequate internal control and an assessment of internal control effective as of the end of the most recent fiscal year. Section 404(b) requires that the CPA firm attest to and report internal control
Reasons for sending attorney letters
To obtain corroboration of the information furnished by management concerning litigation, claims, and assessments, to ask legal counsel to corroborate the information provided by management and to comment on those areas where their views differ from those of management, to ask legal counsel to identify any pending claims, litigation, or assessments that have been omitted from management's list (p. 641 - 642)
Post-Audit Responsibilities of Auditors
When auditors find, subsequent to the issuance of their audit report , that the financial statements are materially misleading, they should take steps to prevent continued reliance on their report. In some cases, this might involve notification of regulatory agencies. (p. 655 - 656)
Use of Component Auditors
When one or more components are audited by component auditors, issues arise about the relative responsibilities of the various auditors. When component auditors are involved, the group auditors should determine whether sufficient appropriate audit evidence cab reasonably be expected to be obtained regarding the overall group controls, the consolidation process, and the financial information of the components
