ACCTG 431 Exam 3 Study Guide

what are we concerned with in auditing debt and equity capital?

That there is proper authorization by appropriate officials in the company or by the board of directors

Identify the circumstances that result in modified opinions

Auditors can issue modified opinions for either misstated financial statements (departing from GAAP) or for an inability to obtain sufficient appropriate evidence to conduct the audit (caused by a scope limitation of not being able

what is the search for unrecorded liabilities?

Procedures designed to detect liabilities that existed at year-end but were omitted from the liabilities recorded in the client's financial statements Primary audit objectives = completeness and cutoff

what is the purpose of a representation letter?

Representation letters are used to have the client's principal officers acknowledge that they are primarily responsible for the fairness of the financial statements

what should auditors do for a type 1 subsequent event?

adjust the financial statement amount

when are auditing procedures generally conducted?

around year-end around the balance sheet date there is little value if it is done before because so much can change in a short period of time

how do small companies ensure proper control?

through segregation of duties for authorizing transactions, custody of stock certificates, and record keeping

emphasis of matter

to emphasize a matter appropriately presented in the financial statements (EX: changing accounting principles, substantial doubt about company going concern, reissued financial statements correcting a misstatement)

What is the purpose of the search for unrecorded liabilities?

to ensure that all owed liabilities are on record and that the liability account balance is correct

why is it necessary to search for unrecorded liabilities?

to make sure that all liabilities that exist are recorded and that liabilities are not understated causing a higher net income

walkthroughs

tracing a transaction from its origination through the company's information system until it is reflected in the company's financial reports

adverse

a material and pervasive departure from GAAP

disclaimer

a material and pervasive scope limitation

qualified opinion

a material but not pervasive departure from GAAP or scope limitation

What is miscellaneous revenue?

a mixture of minor items, some nonrecurring and others received at regular intervals

how do large companies ensure proper control?

through having an independent registrar and stock transfer agent in control of stock issuance

what should auditors do for a type 2 subsequent event?

consider the event for disclosure

what are controls over AP likely to detect?

- Inaccurate recordings of a purchase or disbursement (fraud/ error) - Misappropriation of purchases (fraud) - Duplicate recording of purchase (error) - Late or early recording of cost of purchases (cutoff problems/ fraud)

How are vouchers, shipping documents, invoices, etc used in internal controls over accounts payable?

- Three-way match between vendor invoice, purchase orders, and receiving reports - Segregation of duties between purchasing and disbursements - Getting all vendor invoices approved before paying - Having a numbering system in place for purchase orders and receiving reports

What are management's responsibilities for internal control?

-Accepting responsibility for the effectiveness of their established internal controls -Evaluate the effectiveness using suitable criteria -Support their evaluate with sufficient, credible evidence -Provide a final report on their internal controls

Significant findings from the audit may include:

-Any audit difficulties encountered -Uncorrected mistakes -Disagreements with management -Auditor independence issues -Critical audit matters

What services can the auditor provide related to reporting on whether previously reported material weaknesses continue to exist?

-Auditors are engaged to report on whether material weakness continues to exist -The engagement then focuses on evidence regarding material weakness to determine if management has indeed eliminated their material weakness

How do control deficiencies affect the auditor's opinion on a Company's internal control over financial reporting?

-Control deficiencies are material weaknesses of internal control that can lead to a reasonable possibility that a material misstatement will not be prevented/ detected -These material weaknesses can lead to an adverse auditor opinion Auditor opinions on internal controls can only be unqualified/ unmodified or adverse not in between

How can we use analytical procedures in auditing operations?

-Develop an expectation of the account balance -Determine the amount of difference from the expectation that can be accepted without investigation (use estimates of materiality) -Compare the company's account balance with the expected account balance -Investigate significant deviations from the expected account balance

What do we do to test accrued liabilities?

-Examine contracts and other documents to verify the accrual and assess the accuracy of the recorded liability amount -The client originally computes the accrued liability estimation and auditors recalculate and either confirm or verify completeness to ensure that all liabilities are being presented -For significant estimates, auditors should perform a retrospective analysis of the prior year's estimates for any managerial bias

What are indicators of material weaknesses with internal controls?

-Identification of fraud, whether or not material, on the part of senior management -Restatement of previously issued financial statements to reflect the correction of a material misstatement -Identification by the auditors of a material misstatement in circumstances that indicate that the misstatement would not have been detected by the company's internal control -Ineffective oversight of the company's external financial reporting and internal control by the company's audit committee

scope limitation of internal controls

-Material weakness existed during the year but changed prior to the test date but the auditors do not have sufficient time to test the new system

adverse opinion of internal controls

-Material weakness exists -Incomplete or improperly presented management report on internal control

what are the elements of a non-public audit report?

-Opinion -Basis for opinion -Key audit matters -Management responsibilities -Auditor responsibilities

what are the elements of a public audit report?

-Opinion on the financial statements -Basis of opinion -Critical audit matters

procedures to identify subsequent events

-Reviewing latest financial statements and board meeting minutes -Inquires with management personnel -Obtaining letters from legal team and representations from management

What substantive procedures do we perform over accounts payable and other liabilities?

-Vouch balances payable to selected creditors by inspection of supporting documents -Search for unrecorded accounts payable or liabilities

what controls are there for the payroll cycle?

-extensive segregation of duties -Having employee time reports approved by supervisors -Reconciling payroll bank account monthly -Independent verification of all payroll operations before checks are distributed -Implementation of computer systems that help maintain controls -Frequent payroll reports to the government -Outsourcing payroll duties to a third party

substantive procedures over equity capital

-obtain analysis of capital stock amounts -confirm shares outstanding -reconcile any shares outstanding with the general ledger -Examine accounting methods used over employee stock compensation plans (when management compensation is directly tied to performance causing them to be motivated to fraudulently up the numbers)

what are substantive procedures over debt capital?

-roll-forward analysis -confirm interest bearing debt with given third-party financial institutions -vouch borrowing and repayment transactions -test computations of interest expense, interest payable, and amortization of discount premium -evaluate presentation and disclosure

levels of control deficiency severity

1. Less than significant 2. significant deficiency 3. material weakness (there is a reasonable possibility that a material misstatement will not be prevented or detected)

Generally, should we confirm accounts payable?

AP accounts do not need to be confirmed with third-party creditors

balance sheet items

AR, securities/investments/ notes receivable, PPE, intangibles/ accrued liabilities, interest-bearing debt

when can auditors refrain from determining subsequent events?

After the date of the audit report, auditing team is only responsible for information that is brought to their attention directly

What are the auditors' responsibilities when there is substantial doubt of the entity's ability to continue as a going concern?

Auditors must evaluate managements' assumption about the company's going concern If auditors determine that there is doubt about the company's going concern, they will issue an additional going concern paragraph in their final audit report or a disclaimer of opinion

what is the auditor's approach to analyzing internal controls in an integrated audit?

Audits of internal controls use a top-down approach to identify which controls to test first based on importance

Why is miscellaneous revenue of concern to auditors?

Can be unintentional due to employees not knowing what to do with a certain account or transaction Could also be a result of corporate trying to hide something that they don't want on record

What date is on the audit report?

Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion

what are subsequent events?

Events occurring between the date of the financial statements and the date of the auditor's report

what must auditors communicate to board of directors about control deficiencies?

If auditors conclude that the oversight of the financial reporting and internal controls is ineffective, the auditors must go to the board of directors (this is very rare)

when are the auditors responsible for detecting subsequent events?

In-between the balance sheet date and the date of the audit report

what procedures can be performed over legal and loss contingencies?

Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that the loss will be sustained For legal contingencies, there should be a disclosure in the financial statements for any litigation cases that are probable or reasonably possible to be unfavorable for the company

what is management's responsibility for reporting on internal control?

Management must acknowledge their responsibility for establishing and maintaining adequate internal controls Their filed report must provide an assessment of internal control effectiveness at the end of the fiscal year

What date/period does the auditor report over internal control over financial reporting cover?

The time period for the audit of internal control is an "as of date" meaning only covers what the internal controls look like and operate as of that specific date

why is proper authorization important for debt and equity capital?

These are big transactions with high value so the companies want to make sure that everything is being done correctly and that they are supposed to be occurring

what are the types of subsequent events?

Type 1: conditions existing on or before balance sheet date Type 2: conditions arising after balance sheet date and before the audit report date

roll-forward analysis

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 (does it make sense how we got from point A to point B?)

what must auditors communicate to audit committee about control deficiencies?

any material weaknesses, significant deficiencies, and that any other deficiencies that have been found have been communicated to management (confirmation that they communicated what they were supposed to have communicated)

projected misstatements

arise from sample results projection to population · Management typically does not like this method · Auditors say that a whole population of data or financial statements are incorrect because a sample proved to be inaccurate

what are the risks and assertions involved in accounts payable?

auditors are looking for completeness

what must auditors communicate to management about control deficiencies?

must communicate in writing to management all control deficiencies, regardless of severity

why do accounts payable not need to be confirmed?

because the primary objective of auditing AP is to confirm completeness not existence if you confirmed the AP balance with the creditor is does not hold much weight

judgemental misstatements

differences arising from judgments of management that the auditor considers incorrect

What goes into performing the search for unrecorded liabilities?

examine transactions recorded following year-end such as comparing cash payments after year-end to accounts payable trial balance and examining cash disbursements over specific dollar amounts during the subsequent period

What are the types of misstatements?

factual, judgmental, and projected misstatements

How would the various procedures in this chapter apply in the pandemic era we are living in now?

o For fiscal years 2020 and 2021, the COVID pandemic should be considered a type 1 subsequent event as we have known about it for a while now o Many companies and industries are still dealing with the impacts of the pandemic might require certain disclosures for COVID

what are the additional components of a public audit report?

o Include the words "independent" and "registered" o Addressed to shareholders and management o Includes the year the firm began auditing the client o Signed off by CPA firm not a partner o Dated for when sufficient evidence to make an opinion is met

steps involved in evaluating audit findings

o Review of working papers by auditing staff o Partners review higher risk accounts, and a second partner does a review of the report prior to the audit release o Audit team communicates any fraud or illegal acts, significant deficiencies/ material weaknesses, or any departures from GAAP to the respective governing authorities

procedures to be performed near the end of the audit

o Review the minutes of board meetings (what are the plans for the future and how did they do they against what their plans were for the current year?) o Perform analytical procedures (to support your opinion that you did not miss anything) o Perform procedures to identify loss contingencies o Perform the review for subsequent events o Obtain the representation letter o Communicate misstatements to management Evaluate audit findings

what are the procedures necessary to complete the audit?

o Search for unrecorded liabilities o Review the minutes of meetings o Perform final analytical procedures o Perform procedures to identify loss contingencies o Perform the review for subsequent events o Obtain the representation letter o Communicate misstatement to management o Evaluate audit findings

what are the additional components of a non-public audit report?

o Title includes "independent" o Ordinarily addressed internally to company/ shareholders/ board o Signed off by CPA firm

when is the search for unrecorded liabilities performed?

procedures performed near the date of the auditor's report (examining subsequent cash disbursements)

what should auditors do if they find something in misc. revenue that should not be there?

propose an adjusting journal entry to classify the items correctly and perform analytical procedures to investigate if there are any other unusual transactions in that account

Revenue accounts

sales, interest/dividends/gains, rent, royalties

factual misstatements

specific misstatements identified during the course of the audit for which there is no doubt

What standards do management adhere to in preparing their financial statements and do auditors adhere to in performing their audits?

standards from the PCAOB

Describe the nature of appropriate substantive audit procedures to accomplish the objectives for the audit of revenue and expense accounts

substantive tests to obtain/ prepare an analysis are suggested for the following expense accounts: -R&D expenses -legal/ professional fees -maintenance and repairs -rents and royalties

how should auditors evaluate uncorrected misstatements?

the auditor is to advise the client to make an appropriate disclosure about the facts for anyone that may use the information to rely upon when making other financial decisions If the client refuses to do so, the CPA/ auditor should inform each member of the board and notify regulatory agencies

what is the main concern in auditing AP and other liabilities?

the possibility of understatement or omission of liabilities

what should auditors do when they detect unrecorded liabilities?

there may need to be an adjusting entry depending on the materiality this in turn can have an effect on net income and cumulative effect on the overall financial statements

why are the debt and equity capital accounts considered high-level?

they do not receive action during much of the fiscal year, but when they do it is in large amounts

expense accounts

uncollectible accounts, uncollectible losses/ notes, depreciation repairs, amortization/ various expenses, interest

What is control deficiency?

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

walkthroughs provide evidence to

· Auditors have identified any points at which significant risk of misstatement to relevant assertion exists · The effectiveness of the company's design of internal controls · Confirmation of whether controls have been placed in operation (been properly implemented)

what should auditors look for when examining misc. revenue?

· Collections on previously written-off accounts or notes receivable · Write-offs of old outstanding checks or unclaimed wages · Proceeds from sales of scrap · Rebates or refunds of insurance premiums Proceeds from asset sales

What controls exist over equity capital?

· Ensure proper authority has approved the transaction · Maintain segregation of duties within the process/transaction · Maintain adequate records of equity transactions that occur

What controls exist over debt capital?

· Ensuring authorization by the board of directors · Using an independent trustee to handle debt capital · Cash disbursement controls on interest payments for any bonds or notes payable · Monitor debt provisions for compliance

Identifiers of potential going concerns:

· Negative cash flow from operations · Adverse financial ratios · Defaults on loans · Loss of key franchise or customer

where would an emphasis of matter go in each type of audit report?

· Public company = following the opinion sections · Nonpublic company = following the basis for opinion section

What are the auditor's responsibilities related to subsequent events and what procedures can be performed?

· Review the latest financial reports and minutes of the board and selected committee meetings · Inquire with management about whether or not certain subsequent events exist · Obtain lawyer letters · Obtain representation letter from management (client's officers acknowledge that they are primarily responsible for the fairness of the financial statements)

Additional audit procedures for loss contingencies include

· Reviewing director meeting minutes · Sending confirmation letters · Obtain a representation letter from management to acknowledge the loss contingencies

There should reflect the loss contingency in the financial statements IF

· The amount can be reasonably estimated · It is probable that the loss will be sustained before the balance sheet date

Potential sources of unrecorded AP

· 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

how is the search for unrecorded liabilities performed?

· auditors will examine transactions that were recorded following year-end · comparison of cash payments occurring after the balance sheet date with the accounts payable trial balance is generally the most effective means of disclosing unrecorded liabilities · data analytics can also be used to more accurately identify disbursements that are likely to represent payments for unrecorded liabilities