Audit Chapter 1 & 2 Notes

4 Parts of the CPA exam

1. Auditing & Attestation. 2. Financial Accounting & Reporting (business enterprises, not-for-profit organizations, and governmental entities). 3. Regulation (professional and legal responsibilities, business law, and taxation). 4. Business Environment & Concepts Consists of multiple choice questions and simulations

American Institute of CPAs (AICPA)

1. Establishing standards and rules to guide CPAs in their conduct of professional services. 2. Carrying on a program of research and publication. 3. Promoting continuing professional education. 4. Contributing to the profession's self-regulation.

Audit committees

3-6 independent (non-management_ board members

audit committee

A committee of a corporation's board of directors that engages, compensates, and oversees the work of the independent auditors, monitors activities of the internal auditing staff, and intervenes in any disputes between management and the independent auditors.

direct financial interest

A personal investment under the direct control of the investor.

Sarbanes Oxley Act of 2002

A set of reforms that toughened penalties for corporate fraud, restricted the types of consulting CPAs may perform for public company audit clients, and created the Public Company Accounting Oversight Board (PCAOB)

The primary difference between financial statement errors and fraud is that: A) Errors are unintentional mistakes or omissions, while fraud involves intentional misstatements. B) Errors are intentional misstatements by management, while fraud involves unintentional mistakes or omissions. C) Errors are more likely to provide an indication that an illegal act has occurred. D) There is no difference as errors and fraud have the same meaning.

A) Errors are unintentional mistakes or omissions, while fraud involves intentional misstatements.

Generally accepted accounting principles (GAAP) are distinguished from generally accepted auditing standards (GAAS) in that: A) GAAP are the principles for presentation of financial statements and underlying transactions, while GAAS are the standards auditors should follow when conducting an audit. B) GAAP are the principles auditors follow when conducting an audit, while GAAS are the standards for presentation of financial statements and underlying transactions. C) GAAP are promulgated by the SEC, while GAAS are promulgated by the FASB. D) When GAAP are violated, sufficiently strong GAAS may make up for most GAAP deficiencies.

A) GAAP are the principles for presentation of financial statements and underlying transactions, while GAAS are the standards auditors should follow when conducting an audit.

Under which common law approach is an unidentified third party least likely to be able to recover damages from a CPA who is guilty of ordinary negligence? A) Ultramares Approach. B) Rosenblum Approach. C) Due Diligence Approach. D) Restatement of Torts Approach.

A) Ultramares Approach.

Auditor responsibility for identifying "direct effect" illegal acts differs from their responsibility for detecting: A) Indirect effect illegal acts. B) Fraud. C) Errors. D) Management fraud.

A. Indirect effect illegal acts

How do the rules for the audit of public versus nonpublic companies differ with respect to the independence of a CPA who performs routine accounting services for a cli

AICPA rules state that a CPA can perform bookkeeping and or ccounting services for a client and also maintain independence

Network

An association is considered a network when the relationship among firms includes sharing at least one of the following: 1. Common brand name 2. Common control 3. Profits 4. Common Business strategy 5. Significant professional resources 6. Common quality control policies and procedures

Financial Audit

An audit audit of the financial accounting info of an entity

A CPA is considered 5% responsible for an investor's loss. Under which concept is it most likely that the CPA will be held liable for 100% of the damages if the other defendants are bankrupt? A) Statutory liability. B) Joint and several liability. C) Common law liability. D) Proportionate liability.

B) Joint and several liability.

A common stock investor's burden of proof relating to a CPA's deficiency of performance under the 1933 Securities Act, when compared to the 1934 Securities Exchange Act, is: A) Equal. B) Less. C) Indeterminate. D) Greater.

B) Less.

Under which common law approach are auditors most likely to be held liable for ordinary negligence to a "reasonably foreseeable" third party? A) Restatement of Torts Approach. B) Rosenblum Approach. C) Due Diligence Approach. D) Ultramares Approach.

B) Rosenblum Approach.

When GAAS do not provide "hard and fast rules," they provide subjective guidance which allows auditors to: A) Only apply those standards that are important to the audit. B) Use adequate professional judgment when applying the standards. C) Tailor their audit to procedures requested by management. D) Accurately interpret the profession's Code of Professional Conduct.

B) Use adequate professional judgment when applying the standards.

Ordinarily a claim of negligence against a CPA states that the CPAs performed their duties: A) With wanton disregard to GAAS. B) Without due professional care. C) With reckless disregard of professional responsibilities. D) With reckless disregard to GAAP.

B) Without due professional care.

The Sarbanes-Oxley Act requires that auditors of publicly traded companies in the United States perform an integrated audit that includes providing an audit report on a company's internal control and which of the following? A) Compliance with laws and regulations B) Financial statements. C) Neither financial statements nor compliance with laws and regulations. D) Financial statements and compliance with laws and regulations.

B. Financial Statements

The Sarbanes Oxley Act included provisions establishing the: A) Auditing Standards Board. B) Public Company Accounting Oversight Board. C) Congressional Auditing Overview Board. D) Securities and Exchange Commission.

B. Public Company Accounting Oversight Board

In performing a financial statement audit, which of the following would an auditor be least likely to consider? A) Internal control. B) Quality of management's business decisions. C) Fairness of the financial statement amounts. D) Compliance with GAAP.

B. Quality of management's business decisions

Risks assumed by banks

Business risk - associated with a company's survival and profitability Info risk - risk that the info used to assess business risk is not accurate

What type(s) of liability do CPAs have in the United States? A) Only common law. B) Only statutory law. C) Both common law and statutory law. D) Neither common law nor statutory law.

C) Both common law and statutory law.

The concept of privity may be important in defending auditors against potential claimants. Privity in general only allows: A) Anyone that relied upon the audited financial statements to make a decision to sue the auditor as long as the auditor knew or should have known of such reliance. B) Shareholders who relied upon the audited financial statements to make an investment decision. C) Clients to sue their auditors. D) Lenders of the client to sue the auditor.

C) Clients to sue their auditors.

When the Statements on Auditing Standards use the word "must" relating to a requirement, it means that the auditor: Incorrect Response A) Must comply with the requirements unless the auditor finds that alternative actions are sufficient. B) May use professional judgment in all circumstances in deciding whether to meet the requirement. C) Must fulfill the requirement when it is possible. D) May only decide not to perform the procedure in the audit of a nonpublic company.

C) Must fulfill the requirement when it is possible.

The GAAS of fieldwork pertain most directly to: A) Due professional care in the performance of the audit. B) Improving internal control as a result of the audit. C) The planning of the audit. D) The required training and proficiency of the auditors.

C) The planning of the audit.

The level of assurance provided by an audit of detecting a material misstatement is referred to as: A) Negative assurance. B) Absolute assurance. C) Reasonable assurance. D) High assurance.

C. Reasonable Assurance

Audits of financial statements include an expression of a conclusion about which of the following financial statement characteristics? A) Timeliness. B) Relevance. C) Reliability. D) Governance.

C. Reliability

Establishing "due diligence" is most directly related to court cases tried under: A) Common law by clients. B) The 1934 Securities Exchange Act. C) The 1933 Securities Act. D) Common law by third parties.

C. The 1933 Securities Exchange Act

If an auditor had a substantial stock investment in a client that s(he) was auditing, which of the following would be true? A) The auditor would be violating the IIA standards. B) The auditor would be violating the FASB standards. C) The auditor would lack independence. D) The auditor would be violating the Institute of Management Accounting standards.

C. The auditor would lack independence

Audit of financial statements

Covers balance sheet, IS, RE, and Cash flows

Which of the following is not correct concerning the Securities Act of 1933 and Securities Exchange Act of 1934 with regard to auditor liability? A) The 1933 Act holds auditors to a higher standard of performance. B) Only the 1934 Act is affected by the Private Securities Litigation Reform Act of 1995 provision for proportionate liability under certain circumstances. C) The 1934 Act provides protection to more third parties. D) The 1933 Act relates to common law liability, while the 1934 Act relates to statutory law liability.

D) The 1933 Act relates to common law liability, while the 1934 Act relates to statutory law liability.

The form of attestation that provides the highest form of assurance is a(n): A) Assembly. B) Review. C) Compilation. D) Examination.

D. Examination

The group of generally accepted auditing standards that are personal in nature in that they deal with auditor training and proficiency, auditor independence, and the nature of due professional care are referred to as the: A) Assurance regulation standards. B) Fieldwork standards. C) Personal standards. D) General standards.

D. General Standards

Internal auditors are most likely to issue a report on which of the following? A) Quarterly financial statement reporting. B) Tax compliance. C) Annual financial statement reporting. D) Internal control.

D. Internal Control

A review of a company's financial statements by a CPA firm: A) Concludes with the issuance of a report expressing the CPA's opinion as to the fairness of the statements. B) Is significantly less in scope than an audit and results in a report which provides positive assurance, although not absolute assurance. C) Is similar in scope to an audit and adds similar credibility to the statements. D) Is designed to provide only limited, or moderate assurance.

D. Is designed to provide only limited, or moderate assurance

Which of the following is not a function of the Public Company Accounting Oversight Board? A) Conduct inspections of registered public accounting firms. B) Register public accounting firms that prepare audit reports of publicly traded companies. C) Establish or adopt auditing standards. D) Promulgate accounting principles.

D. Promulgate Accounting principles

With which of the following is the AICPA least concerned? A) Research and development of accounting standards. B) Self regulation of the accounting profession. C) Professional standards for CPAs. D) Standards guiding the conduct of internal auditors.

D. Standards guiding the conduct of internal auditors

Which of the following is not considered a type of audit? A) Financial statement audit. B) Compliance audit. C) Operational audit. D) Sufficiency audit.

D. Sufficiency Audit

Under common law rules, a claimant suing a CPA firm based on an audit of financial statements must prove each of the following EXCEPT: A) Reliance upon the audited financial statements was a proximate cause of the loss. B) The auditors were guilty of either ordinary or gross negligence, depending upon the claimant's recovery rights. C) A loss was sustained. D) The loss sustained was material to the claimant.

D. The loss sustained was material to the claimant.

Big 4

Deloitte, PwC, KPMG, EY

Compliance Audit

Dependent upon the existence of verifiable data and of recognized criteria or standards, such as established laws and regulations or an organization's policies and procedures -EX: audit of an income tax return by an auditor of the IRS, addressing whether a tax return is in compliance with tax laws and IRS regulations

Covered member

Firm, individual, or entity that includes: 1. individual on the attest engagement team 2. individual who has the position to influence the attest engagement 3. managers or certain partners who give nonattest services to the client 4. firm, including the employee benefits plans of the firm 5. partner in the office who si in charge of the attest engagement 6. any entity whose financial operating or accounting policies can be controlled by an entity listed above

Auditors liability - why might they not be held liable

IF they can show that the negligence alleged by the client was not the proximate cause of r the clients loss Demonstrating contributory negligence is one way of showing that the auditors negligence was not the cause

Manager

In large public accounting firms, managers or supervisors perform many of the duties that would be discharged by partners in smaller firms. A manager may be responsible for supervising two or more concurrent audit engagements. This supervisory work includes reviewing the audit working papers and discussing with the audit staff and with the client any accounting or auditing problems that may arise during the engagement.

Main reason small companies get audits?

In order to be approved by a bank for a loan

Internal auditors

Investigate and appraise the effectiveness with which the various org units of the company are carrying out their assigned functions All large corps have this, as well as gov and non for profit orgs

Securities and Exchange Commission

Oversight responsibility for the PCAOB - protect investors and the public by requiring full disclosure of financial information who offer securities for sale to the public

Partner

The lead partner on an engagement is responsible for assuring that the audit is performed in accordance with applicable professional standards. Accordingly, this individual is ultimately responsible for adequate planning, supervision, and execution of the audit. Partners are also responsible for maintaining primary contacts with clients.

1933 Act

a company intending to offer its securities for sale to the public to first file a registration statement with the SEC.7 This registration statement includes audited financial statements and numerous other disclosures. Under the 1933 Act, both the company filing the registration statement and its auditors may be held liable to pur- chasers of the securities in the event that the registration statement is found to contain material misstatements or omissions itors are to avoid liability for the plaintiffs' losses, they generally must affirma- tively prove that (1) they conducted the audit with due diligence, (2) the plaintiffs' losses were not caused by misstated financial statements, (3) the plaintiffs knew of the financial statement misstatement when the securities were purchased, or (4) the statute of limitations—one year after the discovery of the misstatement, but no more than three years after the security was first offered to the public—had expired.

Examination - 3 forms of attestation engagements

audit - when it involves historical financial statements, provides the highest level of assurance CPAs can offer Review - lesser in scope of procedures than an examination, and is designed to lend only a moderate degree of assurance Agreed-upon procedures engagement - results in a report by CPAs that describes those procedures and their findings

Tax Services categories

compliance work (preparation of tax docs) and tax planning (how to structure tax plans)

Public Company Accounting Oversight Board (PCAOB)

created in 2002 to oversee and discipline CPAs and public accounting firms that audit public companies They now oversee securities brokers and dealers

Common law liability

develops through case decisions generally arising due to breach of contract, negligence, and fraud

Statutory law

develops when a governmental unit (state or federal) passes laws and regulations that either implicitly or explicitly impose potential liability on CPAs

ordinary negligence

failure to perform a duty in accordance with applicable standards.

Staff accountant

first position post college - attend training program and work to improve a skill set

International Federation of Accountants

global organization of accounting professional bodies Boards established by IFAC have the following responsibilities: • The International Auditing and Assurance Standards Board (IAASB) estab- lishes International Standards on Auditing (ISAs), International Standards on Quality Control (ISQC), and standards for other assurance and related services. • The International Ethics Standards Board for Accountants (IESBA) estab- lishes ethical standards and guidance for professional accountants. • The International Accounting Education Standards Board (IAESB) develops guidance to improve accounting education around the world

The attest function

includes the preparation of a written report of the CPA's findings

credibility

information can be believed, relied upon by outside stakeholders and other interested third parties

Gross negligence

lack of even slight care, indicative of a reckless disregard for one's professional responsibilities

The stronger the internal control, the ______ testing of financial statement account balances requires by the auditors

less

Breach of contract

occurs when damages result due to a failure of one or both parties to a contract to perform in accordance with the contract's provisions

Board of directors

oversee company's activities

Comparative negligence

permits juries to examine the issue of causation and assess a percentage figure of fault to THE CPAs, any other defendants, and the clients

Attest engagement

practitioner is engaged to issue an examination, review, or procedures report on the subject matter or an assertion about subject matter that is the responsibility of another party

Dodd Frank Act

promote financial stability by improving accountability and transparency in the financial and to protect the iUS taxpayer by ending bailouts of too big to fail institutions

Integrated Audit

publicly traded US companies must have this, and it includes providing assurance on both the financial statements and effectiveness of internal control over financial reporting

CPA

recognition of the public trust afforded to public accountants

Blue sky laws

regulate the issuance and trading of securities within the a specific state

Securities Exchange Act of 1934

requires all companies under SEC jurisdiction to file annual audited and quarterly reviewed financial statements with the SEC.11 The act also creates potential liability for the filing company and its auditors to anyone who buys or sells the company's securities in the event that these annual statements are found to be misleading. While the 1933 Act creates liability only to those investors involved in the initial distribution of a public offering, the 1934 Act expands that liability to sub- sequent purchasers and sellers of the stock.

IRS

responsible for enforcement of the federal tax laws

Senior auditor

role depends on size of engagement smaller engagement - planning and conducting the audit, drafting the report larger engagement - supervising some aspect of the audit, such as audit of the accounts receivable trains staff

Corporate governance

rules, processes, and laws by which businesses are operated, regulated, and controlled

Association

separate legal entities that are designed to help their member firms to increase the availability of services and resources that they provide

Acceptable level of risk noncompliance

situation in which a reasonable and informed third party who is aware of the relevant info would be expected to conclude that a member's ability to comply with the rules is not compromised - for independence, referred to as the acceptable level of risk to independence

Operational audit

study of a specific unit of an organization for the purpose of measuring its performance

Financial reporting framework

suitable criteria in a financial statement audit - such as GAAP

Assurance Services

the broad range of info enhancement services performed by a CPA that are designed to enhance the degree of confidence in the info 2 types: those that increase reliability of the info and those that involve modifying the info so it can be used for decision making

Suitable criteria

the standards that the subject matter of a report should follow - established or developed by groups of experts

independence of mind

the state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment,

Tort

wrongful act, injury, or damage for which a civil action can be brought