ACCT 4301 Exam 1 - Yi-Jing Wu Review Sheet
Know how to interpret causes that may explain significant differences between the auditor's expectations and management reported amounts.
"Even when a significant difference is due to error or fraud, the client may provide a plausible, yet ultimately untrue, business explanation. Thus, the effectiveness of substantive analytical procedures in identifying material misstatement is enhanced when auditors develop potential explanations before obtaining the client's explanation. By doing this, the auditor is better able to challenge the client's explanation."
What are analytical procedures? Know how to distinguish among the 3 types discussed in class: trend, ratio, and reasonableness analysis. •
"evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data" - Trend Analysis: looks at trends over time; comparing prior year balances to current year balances -> Dollar change and % change = ($ change/prior period amount) --> Horizontal analysis - Ratio Analysis: comparison across time or to a benchmark; look at relationships between financial statement accounts or between an account and nonfinancial data -> An auditor NEEDS to know how to interpret common financial statement ratios and other ratios that properly reflect other plausible relations per financial statement accounts. ---> Vertical Analysis - Reasonableness Analysis: develop a model and tests to form expectations
Know why the auditor only provides "reasonable" assurance and not "absolute" assurance regarding the fairness of financial statements. Generally, what level do practitioners and regulators consider "reasonable" assurance to be, as a percentage?
- Absolute assurance is not attainable because of the nature of audit evidence and the characteristics of fraud. - less than 100% --> a high level of assurance, like 95%
What are common causes for significant differences between the auditor's expectations and management's reported amounts?
- Accounting changes • Economic conditions or significant events • Unintentional errors • Fraud (i.e., intentional errors)
What is the difference between accounting records and source documents?
- Accounting records: Items that can be obtained from the company's accountant --> Journal Entries, Trial Balances, Financial Statements - Source documents: Items from a 3rd party --> Sales invoices & Shipping documents
Basic principles of auditor objectivity and independence
- An auditor should NOT audit his or her own work - An auditor should NOT function in the role of management - An auditor should NOT serve in an advocacy role - An auditor should NOT have custody of client assets
Know the direction of testing for occurrence/existence and completeness. Important: Where should you start your sample? You need to know the various documents (e.g., sales invoices, sales subsidiary ledger, etc.) we discussed in class and the purpose each serves. (Refer back to class lecture notes.)
- Occurrence/Existence (Vouching) starts from the accounting records and trace to the source documents -> Looking at inventory on the BS and tracing it back to the physical inventory counts/purchase records to make sure they exist - Completeness (Tracing) starts from the source documents and traces it forward to make sure that they're in the accounting records -> Look at invoices and trace them to an expense account to make sure nothing has been left out
Understand the PCAOB/AICPA audit quality control mechanisms currently in place.
- Take the L -
Be able to recap key takeaways from the Enron video. What was going on during that time in the accounting industry that eventually led to SOX?
- The Sarbanes-Oxley Act of 2002 was passed by Congress in response to widespread corporate fraud and failures. The act implemented new rules for corporations, such as setting new auditor standards to reduce conflicts of interest and transferring responsibility for the complete and accurate handling of financial reports. -The various misdeeds and crimes that Enron's officers and employees committed were extensive and ongoing. Particularly damaging misrepresentations produced inflated earnings reports for shareholders, many of whom eventually suffered devastating losses when the company failed. Many other instances of dishonesty and fraud also occurred, including embezzlement of corporate funds by Enron executives and illegal manipulations of the energy market.
AS 1010: Training and Proficiency of the Independent Auditor
- The audit is to be performed by a person or persons having adequate technical training and proficiency as an auditor. -> Must be educated/experienced specifically in auditing - Begins with formal education and extends into subsequent experience; must be proficient in accounting and auditing - Level of experience should reflect the extent of supervision/review of work needed -> More for an intern, less for a partner
Know management's and auditors' responsibilities with respect to the financial statements.
- The financial statements are management's responsibility. - The auditor's responsibility is to express an opinion on the financial statements. - Management is responsible for adopting sound accounting policies and for establishing and maintaining internal control that will, among other things, initiate, record, process, and report transactions (as well as events and conditions) consistent with management's assertions embodied in the financial statements.
What is the principal-agent problem? How does the modern capital markets structure create the principal-agent problem?
- The principal-agent problem is a conflict in priorities between the owner of an asset and the person to whom control of the asset has been delegated. - The problem can occur in many situations, from the relationship between a client and a lawyer to the relationship between stockholders and a CEO. - The risk that the agent will act in a way that is contrary to the principal's best interest can be defined as agency costs. - Resolving a principal-agent problem may require changing the system of rewards in order to align priorities or improving the flow of information, or both. --> Principal provides capital and hires agent to manage resources; agent knows about the day-to-day and hires the auditor to reduce information risk for the principal
Know how to interpret key financial ratios (ratio handout provided when we covered chapter 5 on analytical procedures- available on Blackboard). You DO NOT need to memorize financial ratio formulas; however, you must know how to interpret these ratios. What do they mean? What do they say about a company's financial position/strength? Also know other ratios that provide auditors with a more complete picture of the client's financial position (e.g., AR as % of sales, allowance as % of AR or Sales, inventory as % of current assets, etc.).
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Know the 3 different types of confirmations. Know the order of evidence reliability among the 3 types of confirmations.
-> Positive confirmation without balances (blank) - reply required -> Positive confirmation with balances - reply required -> Negative confirmations - reply only when there is a disagreement with balances
Know the major activities involved in the audit planning stage
1.) Client acceptance and continuance - Evaluate the prospective client -> Review financials, reputation in the community, chat with their previous auditor, is management trustworthy?, unusual business?, evaluate independence issues, any regulatory violations -> Engagement Risk: the risk of loss or injury to professional practice stemming from litigation, adverse publicity, or other events arising in connection w/ the audit. - Auditor has limited control during the client acceptance and client continuance stages 2.) Preliminary engagement activities including assessing compliance with independence rules - Establish engagement team and time budget -> Engagement Letter, Staffing needs, Are specialists needed (e.g., actuary, IT and tax personnel), Preliminary budgeted hours - Assess compliance with independence rules 3.) Plan and audit - When preparing the audit plan, the auditor should be guided by the results of the risk assessment procedures performed to develop the overall audit strategy and prepare the audit program. -> What audit procedure/tests are to be performed should be documented?
What are the different types of audit tests or procedures (i.e., risk assessment, test of controls, substantive analytical procedures, and substantive test of details)? What is the key objective(s) accomplished by each type of test? •
1.) Risk Assessment Procedures: help to determine the nature, timing, and extent of audit testing 2.) Test of Controls: Tests directed toward the evaluation of the effectiveness of the design and operations of internal controls over financial reporting -> Inquire mngmnt, supervisors, and staff -> Inspect documents, reports, and e-files -> Observe application of specific controls -> Walkthroughs -> Reperformance of the application of the control by the auditor 3.) Substantive Procedures: designed to detect material misstatements in a class of transactions, account balance, and disclosure components of the financial stmts - Some amount required for all significant account balances and classes of transactions a.) Substantive Analytical Procedures: Evaluations of financial info through analysis of plausible relationships (look at trends/ratios) among both financial and nonfinancial data -> Investigating identified inconsistencies in data b.) Test of Details: Detect monetary misstatements in individual transactions processed through all accounting applications -> Substantive test of transaction: tests for errors/fraud in individual transactions -> Test of details of account balances and disclosures focus on the items that are contained in the ending financial stmt account balances/disclosures
Know how to evaluate the persuasiveness of audit evidence based on the following dimensions: sufficiency and appropriateness (reliability and relevance). Review lecture notes/video and Case #1
1.) Sufficiency (amount) -> Quantity of evidence 2.) Appropriateness (quality) -> Reliability: can this evidence be relied upon to signal the true state of an assertion? -> Relevance: is the audit evidence relevant to the assertion being tested?
What is the purpose of an engagement letter? What key information are usually included in an engagement letter? •
A contract for the audit ‐ written agreement between auditor and client • Identify agreed upon services ‐ review vs. audit • Includes: - Services to be rendered - Responsibility for financial statements and limitations - Important dates for the audit - Fees - Arrangements regarding use of specialists or internal auditors - Signed by auditor and signed acceptance by client
What is external auditing?
A systematic process of objectively obtaining and evaluating evidence regarding assertions about economic actions and events to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to interested users.
Know the PCAOB "GAAS standards." IMPORTANT: You must know in detail contents of the 4 PCAOB standards (these are the links to the PCAOB website provided in BB). For key takeaways of each standard please see my summary in the lecture notes for Chapter 2. Know how to identify situations in which the auditor may have violated any of the PCAOB GAAS standards and explain why by citing the standards as we did with the homework problem from chapter 2.
AS 1001: Responsibilities and Functions of the Independent Auditor AS 1005: Independence AS 1010: Training and Proficiency of the Independent Auditor AS 1015: Due Professional Care in the Performance of Work
What are the evidence requirements that the auditor needs to satisfy to comply with the following GAAS?
AS 1015- The independent auditor's objective is to obtain sufficient appropriate evidential matter to provide him or her with a reasonable basis for forming an opinion. • professional judgment in evaluating the reasonableness of accounting estimates • In the great majority of cases, the auditor has to rely on evidence that is persuasive rather than convincing
Know the primary objectives for each type of analytical procedures (e.g., preliminary, substantive, and final). According to auditing standards, which types of analytical procedures are permitted vs. required?
Analytical Procedures are to examine fairness and/or detect material misstatements - Preliminary: attention directing‐ help guide risk assessment process (i.e., identify financial statement accounts that are likely to contain errors) ---> REQUIRED to be used in planning all financial statement audits - Substantive: Reduce level of detail tests ---> PERMITTED but NOT REQUIRED to be applied during substantive testing - Final: serve as a final check to ensure auditor has explanations and collaborative evidence for unexpected differences; overall review of financial information ---> REQUIRED to be used at the end of the audit
Know management's assertions related to transactions, accounts, and disclosures. Know and understand the definitions of each assertion as well as how to apply them.
Assertions are expressed or implied claims/representations made by management in the financial statements. • Also serve as "audit objectives" for audit work
Know the definition of independence and the AICPA's definition of independence (i.e., independence in mind and independence in appearance)
Auditor independence -free of conflicts of interest that would cause the firm to be biased either for or against the attest client AICPA definition: - Independence in mind ‐"The state of mind that permits the performance of an attest service w/o being affected by influences that compromise professional judgment." - Independence in appearance -"The avoidance of circumstances that would cause a reasonable and informed third party to reasonably concluded that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team has be compromised. --> Independence in appearance is more important than independence in mind ---> all about having the public's trust, so don't look shady
Auditors are hired by the agent (i.e., company). How is this a problem for auditors in terms of maintaining an attitude of objectivity and independence?
Because the agent is paying the auditor to report on the fairness of their financial reports, so an auditor could be bribed to make issue a clean opinion since the financial stmt creator is the one paying the auditor --> Auditor's have to remember that their loyalty is to the principal (owner), not the agent (manager)
Know how to identify and distinguish among the various types of audit tests/procedures (not to be confused with type of audit evidence) •
By performing audit tests/procedures, the auditors obtain "audit evidence" Tests/Procedures: Risk assessment, Test of Controls, Substantive Analytical Procedures Evidence: Inspection of tangible assets, Confirmations, Reperformance, Recalculation, Inspection of records/documents, Scanning, Inquiry, Observation Assertions: Occurrence/Existence, Completeness, Authorization, Accuracy, Cutoff, Classification, Valuation
Understand the role and responsibilities of audit committees post-Sarbanes-Oxley Act for publicly traded companies •
Committee members must be: • Member of board of directors and independent. • Directly responsible for overseeing work of any registered public accounting firm employed by the company. • Must preapprove all audit and non audit services provided by its auditors. • Must establish procedures to follow for complaints. • Must have authority to engage independent counsel. --> No specific requirements for privately held companies
Know why it is necessary to use common-size financial statements when performing intercompany comparisons? Know how to prepare a common-size income statement and balance sheet.
Common-size analysis converts financial stmt amounts to percentages, comparing apples to apples -> This makes it easier to analyze a company over time and compare it to it's peers; it can spot trends that raw financial stmts don't -> Common-size I/S: express balances as a % of sales or net sales -> Common-size B/S: express balances as a % of total assets or total liabilities
Why is it so important that auditors maintain their ethics and independence?
To provide credible source of assurance (reduce information risk), auditors need to have a solid reputation for competence and for unquestioned character and integrity
What is TM? Why is it necessary to allocate the PJM across accounts? What other factors may affect auditors TM judgments?
Tolerable Misstatement: Allocation of materiality at the individual account level • Usually 5 -15% of balance or 50 -75% of PJM -> Establish a scope for audit procedures at the individual account level -> Propose AJEs for misstatements at the account level if they're greater than TM Factors that affect TM judgement: - Qualitative factors (e.g., complexity of account, debt covenants, closeness to meeting benchmark, etc.) - High risk of misstatements within the account balance or transactions - Prior year audit adjustments - High turnover of senior management or key financial reporting personnel - Precision of audit procedure
Why is it necessary to perform comparative analysis? What are the various types of comparative analysis, auditor may perform to assess the reasonableness of the client's financial performance?
You need to compare your client's performance to other benchmarks in order to fully understand whether or not your client's financial stmts are reasonable - Intracompany analysis ---> comparison between branches or employees within the same company - Intercompany analysis ---> comparison between two or more different companies - Compare client data with industry data - Compare client data with client ‐determined expected results - Compare client data with auditor ‐determined expected results - Compare client data with expected results, using non‐financial data
Know the common non-audit services banned for publicly traded financial statement clients.
• Bookkeeping • IS design and implementation • Appraisal or valuation services • Actuarial services • Internal audit outsourcing services • MGMT functions • Legal services • Expert services • Broker or dealer, investment adviser, or investment banking services Exception: Firms may provide tax services to audit clients -> Audit committee required to pre‐approve other non audit services --> Committee is acting as the "client" for this
What is the difference between known vs. likely misstatements?
Known - misstatements are certain and have been found Likely - difference in judgement/estimate/extrapolation of audit evidence -> Allowance for doubtful accounts is an account that's balance is based on an estimate --> the auditor's range was from $250K to $285K ; the client estimated $225K -----> this would be a likely misstatement of $25K understated
Know auditors' possible actions when aggregate misstatement is greater than PJM and when it is less than PJM
Less than PJM: -> Issue clean audit opinion, unless qualitative factors indicate an adjustment is necessary Greater than PJM: -> Client will need to record adjustments to decrease misstatements below PJM -> Sample more (i.e., increase testing) -> Modify audit opinion, if client is unwilling to make proposed audit adjustment
What is the difference between known vs. likely misstatements? . How should auditors evaluate an audit difference (or error) between the auditors' determined range and the point estimate provided by the client? See example in lecture notes and discussed in class related to allowance for doubtful accounts.
Likely misstatements are typically associated with accounts requiring judgment -> Allowance for doubtful accounts, depreciation
What is a dual-purpose test? Know how to identify when a specific test is a dual-purpose test. •
One audit procedure that tests both the operating effectiveness of internal controls and detects monetary misstatements - These can improve the efficiency of the audit -> Agree a sample of shipping documents to their respective sales invoices and to the sales journal. --> this test checks both the effectiveness of the control and provides evidence on if the sales invoice contains the wrong quantity, product type, or price
Know why it is possible for aggregate TM across all accounts to be greater than PJM.
PJM is the "safety net" ; individual unadjusted misstatements can be less than TM at the account level, but when added together they might be material to the financial stmts as a whole --> Many small errors can lead to an overall large error
Understand the environment that the audit profession functioned in pre-2002. Understand key post-Sox changes
Pre‐2002 SOX Environment • Economic boom resulted in a more, more, more society • Accounting firm's competition for business - Audit fees are forced to be lower‐ look to other sources of revenue • Emphasis on growth and increasing non audit services - Auditors become more than auditors (non audit services) - INDEPENDENCE ISSUES - Consulting fees exceeded financial statement audit fees - When the auditor lacks independence then the value of his/her services have no value • Incentive compensation pressures (auditors and management) - Shift in audit partners' compensation to selling ("marketing") services • Self‐regulation of auditing profession Post‐SOX 2002 • Sarbanes‐Oxley Act of 2002 (SOX) changed audit profession - End of "self‐regulation" for public company audits - Created Public Company Accounting Oversight Board (PCAOB) (improved regulation of auditors) • Inspections of audits - audit deficiencies of firms are made public - Rotation of lead audit partners (every 5 years) • Trade‐off between experience/expertise and independence - Audit firms must make additional reports to both audit committee and public regarding internal controls ---> This is all in place to increase investors' confidence in the quality of the audits and the honesty of the companies they're investing in
What does precision of the auditor's expectation mean? What are the relations between materiality and precision of expectation?
Quality of an expectation -how closely the auditor's expectation approximates the "correct" but unknown amount -> A solid understanding of the company's business and environment is key to setting appropriate expectations Factors affecting precision of analytical procedures: - Disaggregation of data • Monthly vs. Annual, individual revenue account vs. aggregate of all revenue accounts - Plausibility and Predictability of relationships • I/S usually more predictable than B/S accounts - Data Reliability - Type of Analytical Procedures Used to Form Expectations • Trend, ratio, and reasonable analysis
Know how to justify your PJM determination. What are some important qualitative factors that may alter the auditor's PJM judgment? The table of PJM benchmarks and reasonable range of %s will be provided. Therefore, no need to memorize the table in the book. However, you have to know how to apply benchmarks and justify judgments.
Quantitatively: materiality is a percentage of some base/benchmark Qualitatively: -1st year engagement, fraud risks, management turnover, control weaknesses, factors that increases inherent risk, prior year recorded and unrecorded audit adjustments, small amounts that may cause missing some benchmark, potential of fraud, volatile business environment , potential loan covenant violations --> If the client has a higher risk of fraudulent activities due to qualitative factors, then maybe adjust PJM
Know the 3 steps in applying materiality on an audit. Know how to determine PJM and TM. Know how to evaluate audit evidence (at the overall financial statement level and at the account level). When should PJM be used and when should TM be used to evaluate errors discovered during the audit?
Step 1: Determine a materiality level for the overall financial stmts -> Preliminary Judgement of Materiality (PJM); Materiality of the financial stmts as a whole Step 2: Determine Tolerable Misstatement (TM) -> Materiality at the account level Step 3: Evaluate audit findings
Know the definition/meaning of materiality. Why is materiality important (during planning, evidence evaluation, and reporting stages of the audit)?
The magnitude of a misstatement that would likely change the judgment of a reasonable financial stmt user 1.) Planning: (how much testing should be performed on a given balance AND which accounts are deemed important to test?) 2.) Evidence evaluation/sampling: (how important is a particular misstatement or omission that gets discovered during the audit?) 3.) Reporting: (Is the sum of material misstatements enough to warrant an other‐than‐unqualified opinion?)
Know the order in which the auditor should fill up the "assurance bucket" for each account/assertion Understand the audit testing hierarchy. •
Hierarchy -start with the Test of Controls and Substantive Analytical procedures, end with Test of Details -> TOC determines how much testing needs done -> SAP determines the high risk areas to focus on --> Both of these are cheaper for the auditors to perform because they target a slew of things while Test of Details focuses on one transaction or balance at a time Order for the Assurance Bucket: start from the bottom of the bucket and work your way up 1.) Evidence from risk assessment procedures 2.) Test of Controls 3.) Substantive Analytical Procedures 4.) Remaining assurance from test of details
AS 1005: Independence
In all matters relating to the assignment, an independence in mental attitude is to be maintained by the auditor or auditors. - The general public maintain confidence in the independence of independent auditors - To be independent, the auditor must be intellectually honest; to be recognized as independent, he must be free from any obligation to or interest in the client, its management, or its owners - Independent auditors should not only be independent in fact; they should avoid situations that may lead outsiders to doubt their independence. -> Independent in mind and appearance
Management Assertions about Disclosures
- Occurrence and rights and obligations - disclosed events, transactions, and other matters have occurred and pertains to the entity - Completeness - No disclosures are left out - Classification and understandability - Things are presented in a manner that is appropriate and clear - Accuracy and valuation - Things a) are presented in a manner that is clerically accurate and b) are appropriately valued
AS 1015: Due Professional Care in the Performance of Work
- An auditor should possess "the degree of skill commonly possessed" by other auditors and should exercise it with "reasonable care and diligence" (that is, with due professional care) - requires the auditor to exercise professional skepticism -> a questioning mind and a critical assessment of audit evidence - auditor uses the knowledge, skill, and ability called for by the profession of public accounting to diligently perform, in good faith and with integrity, the gathering and objective evaluation of evidence - allows the auditor to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud, or whether any material weaknesses exist as of the date of management's assessment -> Absolute assurance is not attainable because of the nature of audit evidence and the characteristics of fraud - independent auditor's objective is to obtain sufficient appropriate evidential matter to provide him or her with a reasonable basis for forming an opinion. -> reasonableness of accounting estimates -> usually has to rely on evidence that is persuasive rather than convincing - Auditors should be assigned to tasks and supervised commensurate with their level of knowledge, skill, and ability so that they can evaluate the audit evidence they are examining -> The engagement partner is responsible for the assignment of tasks to, and supervision of, the members of the engagement team
AS 1001 Responsibilities and functions of independent auditor
- Auditor has to express an opinion on whether the financial statements presented conform with GAAP and identify places where they don't - Plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud -> Reasonable assurance, not absolute -> Only responsible for MATERIAL misstatements - Creating the financial stmts & footnotes is management's responsibility - Auditor must be educated/trained/qualified to conduct the audit so that they can use their "professional judgement"
Management Assertions about Account Balances
- Existence - Assets, liabilities, and equity interests exist - Rights and Obligations - company holds or controls the rights to assets, and liabilities are the obligations of the company - Completeness - All assets, liabilities, and equity interests that should be included in balances are recorded - Valuation (and allocation) - All assets, liabilities, and equity interests are appropriately valued and recorded - Accuracy - Correct amounts are recorded - Cutoff - Everything is recorded in the correct accounting period - Classification - assets, liabilities, and SE have been recorded in the proper accounts
What are the common attest services that must follow Rule 101 regarding independence?
- Financial statement audits - Internal control audits -Other attest services as defined in the Statements on Standards for Attestation Engagements (SSAEs) - Financial statement review
Understand instances in which non-audit services are allowable for non-public client audits.
- Help to implement audit systems (can't develop it) - Tax planning - Outsource the internal audit function (no mngmt functions) - Develop projections/forecasts for the company's new products -> Auditor can't audit their own work!
Why is there demand for auditing services? Understand how information asymmetry and conflicts of interest between managers and investors result in demand for auditing. How does the audit function mitigate the moral hazard problem that exists between management and outside stakeholders (e.g., investors and lenders)? How does the audit reduce information risk for outside stakeholders?
- Information asymmetry: The concept that the manager generally has more information about the true financial position and results of operations of the entity than the absentee owner does. - Reporting: The end product of the auditor's work, indicating the auditing standards followed and expressing an opinion as to whether an entity's financial statements are fairly presented in accordance with agreed-upon criteria (e.g., GAAP). --> We need a third party to check on the financials and make sure there isn't fraud
Know how to identify each type of audit evidence (e.g., inspection of assets, confirmations, observation, etc.) and know the degree of reliability for each type (low, moderate/medium, or high)
- Inspection of records and documents - Evidence obtained from external documents is more reliable than evidence obtained from internal documents. (medium reliable) - Inspection of tangible assets - physical examination of a tangible asset (highly reliable) - Observation - The process of watching a process or procedure being performed by others (low reliable) - Inquiry - Ask clear, concise, and relevant questions (low reliable) - Confirmation - The process of obtaining a representation of information or of an existing condition directly from a third party (highly reliable for positive, blank) - Recalculation- Determining the mathematical accuracy of documents or records. (highly reliable) - Reperformance - The auditor's independent execution of procedures or controls that were originally performed by company personnel. (highly reliable) - Analytical Procedures - Evaluations of financial information made by a study of plausible relationships among both financial and nonfinancial data. (medium reliable) - Scanning - Review of accounting data to identify significant or unusual items (medium reliable)
For a particular audit procedure/test, know how to identify the assertion(s) being tested and type of evidence. (Refer to examples in handout on audit procedures/evidence and to the Handout for homework 2.)
- Look at examples -
According to Rule 301, under what circumstances is it appropriate for the auditor to disclose confidential information without the client's consent?
- Meet disclosure requirements of GAAP and GAAS - Peer or PCOAB reviews - Comply w/ valid and enforceable subpoena - Investigative or disciplinary proceedings - Review CPA firm's practice in conjunction with merger or sale
Management Assertions about Transactions
- Occurrence (validity) - All transactions that are recorded actually occurred (i.e., Nothing fictitious gets recorded) - Completeness - No transactions are left off the company's books - Authorization - Nothing happens in the company's business or its books without proper approval - Accuracy - Correct amounts are recorded - Cutoff - Everything is recorded in the correct accounting period - Classification - Transactions/events get recorded to the proper accounts
Know when the CPA firm's independence is impaired.
Client has unpaid audit fees (>1 yr. prior to date of audit report) -> Does not apply when a client is in bankruptcy CPA firm's benefit plans invested in firm's attest clients Perform banned non-audit services for attest clients When the lead and review partner on the engagement is on the engagement for more than 5 consecutive years When a former member of audit team goes to work for the client in a "financial reporting oversight role" (need 1 year cooling off period) Audit partner receives compensation based on selling "other" engagements Litigation
Know the general rules that may impair an auditor's independence with respect to financial interests, business relationships, family relationships, employment relationships, scope of the firm's services, and fee arrangements. Know how to identify violations of independence rules and explain why.
Financial Interests: prohibits covered members to have direct or material indirect financial interest in the audited company (e.g., investments and/or loan to client) -> Direct - ownership, control over entity, beneficially owned through an intermediary -> Indirect - these are permissible if the amount involved is immaterial with respect to the covered member's income and wealth Business Relationships: impaired if an auditor performed managerial, other significant role for the audited company, and/or act as a trustee of the audit client's estate -> if they made management decisions on behalf of the client or exercised authority over a client's operations/business affairs Employment Relationships - arises when a former auditor goes (or intends) to work for his/her client or employee of client goes to work for audit firm -> impaired if auditor accepts a key position with the client (someone who has the ability to manipulate the accounting records) --> Rule requires that when a former member of audit team goes to work for the client in a financial reporting oversight role, needs 1 year cooling off period ---> At the firm level: audit team member can't be on that client's engagement, ee of client that is now an auditor can't be on the engagement Family: Immediate family (spouse, spousal equivalent, or dependent) - mostly same independence rules as a covered member - Can't be in a key position for the audited company or have a financial interest in them Close relatives (parent, sibling, or nondependent children) - Don't normally impair independence, unless -> Covered member is aware of the close relatives material financial interest -> Financial interest enable close relative to exercise significant influence -> Close relative in key position
Know the role of the following regulatory agencies and their functions: SEC, PCAOB, AICPA (ASB), IAASB, ISB, and FASB. Which set of auditing standards governs audits of non-publicly traded companies and which set governs audits of publicly traded companies?
SEC: Oversees the establishment of of accounting and auditing standards in the US --> Public PCAOB: Established by Congress to oversee the audits of public companies in order to protect the interest of investors and the further public interest in the preparation of informative, accurate, and independent audit reports. --> Public AICPA: Performs a number of functions that directly bear on the activities of member CPA's. Houses several standing committees. They spread info about the rules/standards that guide audit and related services provided to nonpublic companies --> Non public IAASB: is an independent standards body that issues standards, like the International Standards on Auditing, quality control guidelines, and other services, to support the international auditing of financial statements. --> Public IASB: International counterpart of FASB that recognizes accounting standards outside the US FASB: establish standards for financial accounting and reporting
Why is it so important for users of financial statements to perceive the external auditor to be independent (both in mind and appearance)?
So that they know they can trust the audit to be done without fraud or misrepresented facts --> People wouldn't want to invest in a company if they thought that the auditor was in cahoots with management to show inflated revenues and deflated expenses ---> no shenanigans or appearance of shenanigans
What is tolerable difference (TD)? Know possible ways TD is determined. When the auditor performs substantive analytical procedures, know how to apply the decision process regarding auditors' comparisons of expectations to client's recorded balances. What should the auditor do when the difference between expectation and recorded amounts exceed TD? Know when auditors should benchmark substantive testing results (either substantive test of details or substantive analytical procedures) to TM vs. TD.
The amount/percentage of difference between the auditor's expectation and client's recorded amount that is tolerable by the auditor. - Differences that exceed TD would require further investigation - Size of TD depends on the significance of the account, the desired degree of reliance on the substantive analytical procedure, the level of disaggregation, and precision of expectations --> Tolerable Difference is always lower than PJM ---> It can be some % of Tolerable Misstatement or Preliminary Judgement of Misstatement and some % change -----> TD = 50% of TM and 10%
Know the relation between TM and amount of testing. For instance, when TM increases the amount of testing will increase or decrease?
There is an INDIRECT relation between TM and amount of testing. That is as TM DECREASES the amount of testing INCREASES. -> The lower the dollar amount threshold that would be tolerable as a misstatement, the easier it is for red flags to be raised, which leads to more testing --> more transactions will reach the TM threshold for testing
Who are considered covered members when applying independence rules?
a.) An individual on the client's attest engagement team b.) An individual in a position to influence the client's attest engagement c.) A partner or manager who provides more than 10 hours of non attest services to the attest client engagement d.) A partner in the office in which the lead attest engagement partner primarily practices in connection with the client's attest engagement e.) The firm, including the firm's employee benefit plans f.) An entity whose operating, financial, or accounting policies can be controlled by any of the individuals or entities described in items (a)-(e) or by two or more such individuals or entities if they act together. --> Anyone who is bound by the independence requirements
