Audit Chapters 3 & 5

Completeness

*Keyword understatement* -All assets, liabilities, equity interests, and transactions that should have been recorded have been recorded.

Existence and Occurrence

*keyword overstatement* - Assets, liabilities, and equity interests exist and recorded transactions and events have occurred

Estimation Transactions

A transaction involving management's judgments or assumptions, such as determining the allowance for doubtful accounts, establishing warranty reserves, and assessing assets for impairment.

Nonroutine Transactions

A transaction that occurs only periodically, such as counting and pricing inventory, calculating depreciation expense, or determining prepaid expenses.

Rule 505

- A member may practice public accounting only in a form of organization permitted by state law or regulation, whose characteristics conform to resolutions of Council. - A member shall not practice public accounting under a firm name that is misleading. Names of one or more past owners may be included in the firm name of a successor organization. - *A firm may not designate itself as "Members of the American Institute of Certified Public Accountants" unless all of its owners are members of the Institute.*

List of Relevant Assertions

- Existence and Occurrence - Rights and Obligations - Completeness - Cutoff - Valuation, Allocation, and Accuracy - Presentation and Disclosure

Reasonableness Test

- Similar to regression analysis in that an explicit expectation is computed for the financial statement amount using financial or non financial data. - Different from regression analysis in that it is less formal and is not based on a statistical model

Interpretation 101-3: Examples of General Activities that Would Impair a CPA's Independence (Review Figure 3.7)

- setting policies or strategic direction for the client -Directing or accepting responsibility for the actions of the client's employees, except as allowable for using internal auditors to provide assistance -Authorizing, executing, or consummating a transaction -Preparing source documents (purchase orders, etc.) -Having custody of client assets -Supervising client employees in their normal recurring activities

Immediate Family Interests

-A spouse, spousal equivalent, or dependents -subject to independence requirements -Interests of CPAs and immediate family members are indistinguishable from each other *2 exceptions:* 1. A family member may be employed with the attest client if the family member is not in a position to influence the client's financial settlements 2. In certain circumstances, an immediate family member of a covered member can hold a financial interest through an employer's benefit plan

How long do you retain work papers?

-If it is a public company, 7 years -If it a non public company, 5 years

Types of Audit Procedures

-Inspection of records and documents -Inquiry of knowledgeable persons within or outside the entity -External confirmation -Inspection of tangible assets -Observation of processes or procedures being performed by others -Recalculation of mathematical accuracy -Reperformance of procedures -Analytical Procedures

Audit Evidence is More Reliable When it is

-Obtained from knowledgeable independent sources outside the client company rather than nonindependent sources -Generated internally though a system of effective controls rather than ineffective controls -Obtained directly by the auditors rather than indirectly or by inference -Documentary in form rather than in the form of an oral representation -Provided by original documents rather than photocopies or fasimiles

Procedures formed so Auditors know the client's financial statements follow GAAP

-Risk Assessment Procedures -Tests of Controls -Substantive Procedures

Framework for Ethical Decisions

1. Identify the problem 2. Identify possible courses of action 3. Identify any constraints relating to the decision. 4. Analyze the likely effects of the possible courses of action. 5. Select the best course of action.

Cutoff

-Transactions and events have been recorded in the correct accounting period *bills and hold scheme- bill client and hold inventory until the period is over*

Interests of Close Relatives

-parents, siblings, or nondependent children -this standard applies to (1) members of the attest engagement team, (2) individuals in a position to influence the attest engagement, and (3) any partner in the engagement office -Independence is impaired if this person has: 1. a key position with the client, or 2. A financial investment in the client that -is material to the close relative and of which the accountant has knowledge; or -enables the close relative to exercise significant influence over the client

How auditors obtain an understanding of how manage develops estimates

1. Review and test management's process of developing the estimates, which often involves evaluating the reasonableness of the steps performed by management 2. Independently develop an estimate of the amount to compare to management's estimate 3. Review subsequent events or transactions bearing on the estimate, such as actual payments of an estimated amount made subsequent to year-end.

Broad Categories of Threats to Independence (Review Figure 3.3) Pg. 74

1. Self-Review 2. Advocacy 3. Adverse Interest 4. Familiarity 5. Undue Influence 6. Financial Self-Interest 7. Management Participation

Tests of Details Divided Into Three Types

1. Tests of Account Balances 2. Tests of Classes of Transactions 3. Tests of Disclosures

Within the Board of Directors There Are:

1. The Audit Committee 2. Ethics & Compliance 3. Nominating 4. Risk & Governance

Internal Standards

The result of your religious or other beliefs about the manner in which you should behave and make decisions.

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. -Must be independent directors

Permanent File

A file of working papers containing relatively unchanging data, such as copies of articles of incorporation and bylaws; copies of minutes of directors', stockholders', and committee meetings; and analyses of such ledger accounts as land and retained earnings.

Relevant Assertion

A financial statement assertion that has a reasonable possibility of containing a misstatement or misstatements that would cause the financial statements to be materially misstated. -Made without regard to the effect of controls

Vertical Analysis or Common-Size Financial Statements

A form of analysis that presents financial statement amounts for a period as a percentage of some financial statement base.

Minutes

A formal record of the issues discussed and actions taken in meetings of stockholders or the board of directors

Rule 301-Confidential Client Information (pg. 87)

A member in a public practice shall not disclose any confidential client information without specific consent of the client. -*called loose talk* -can reveal information if there is a court order

Rule 101-Independence (review figure 3.5)

A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.

Rule 502

A member in public practice shall not seek to obtain clients by advertising or other forms of solicitations in a manner that is false, misleading, or deceptive. Solicitation by the use of coercion, overreaching, or harassing conduct is prohibited.

Rule 501

A member shall not commit an act discreditable to the profession *Look at chart Pg. 89*

Direct Financial Interest

A personal investment under the direct control of the investor.

Manager

A professional employee of the public accounting firm who either has continuing responsibility for the overall planning and supervision of engagements or has the authority to determine that an engagement is complete subject to final partner approval, if required.

Past Due Professional Fees

A public accounting firm's independence is considered impaired if fees for professional services rendered in prior years have not been collected before issuance of the CPA's report for the current year.

Representation Letter

A single letter or separate letters prepared by officers of the client company at the auditors' request setting forth certain representations about the company's financial position or operations.

Ethical Dilemma

A situation that an individual faces involving a decision about appropriate behavior. Generally the welfare of one or more other individuals is affected by the results of the decision.

Electronic Data Interchange

A system in which data are exchanged electronically between the computers of different companies. In an EDI system, source documents are replaced with electronic transactions created in a standard format.

Horizontal Analysis

A technique that involves comparing financial statement amounts and ratios for a particular company from year to year

Cross-Sectional Analysis

A technique that involves comparing the client's ratios for the current year with those of similar firms in the same industry. *comparing client's ratios to industry averages*

Routine Transactions

A transaction for a recurring financial activity recorded in the accounting records in the normal course of business, such as sales, purchases, cash receipts, cash disbursements, and payroll

Related Party Transactions

A transaction in which one party has the ability to influence significantly the management or operating policies of the other party, to the extent that one of the transacting parties might be prevented from pursuing fully its now separate interests.

Reclassification Journal Entry

A working paper entry drafted by the auditors to assure fair presentation of the client's financial statements, such as an entry to transfer accounts receivable credit balances to the current liabilities section of the client's balance sheet. -Not posted to the client's ledger accounts

Working Trial Balance

A working paper that lists the balances of accounts in the general ledger for the current and the previous year and also provides columns for the auditors' adjustments and reclassifications and for the final amounts that will appear in the financial statements. - *the "backbone" of the entire set of audit working papers*

Profession

An activity that involves a responsibility to: 1. serve the public 2. has a complex body of knowledge 3. has standards for admission 4. has a need for public confidence.

Independence Impaired For a Covered Member If:

A. During the period of a professional engagement: 1. Had or was committed to acquire any direct or material indirect financial interest in the client. 2. Was a trustee of any trust or executor or administrator of any estate if such trust or estate had or was committed to acquire any direct or material indirect financial interest in the client and: i) The covered member had the authority to make investment decisions for the trust or estate; or ii) The trust or estate owned more than 10 percent of the client's outstanding equity securities or other ownership interest or the value of the trust's estate's holdings in the client exceeded 10 percent of the total assets of the trust or estate. 3. Had a joint closely held investment that was material 4. Had any loan to or from the client, any officer or director of the client, or any individual owning 10 percent or more of the client's outstanding equity securities or other ownership interests.

Individual in a position to influence the attest engagement

An individual who (a) evaluates the performance or recommends the compensation of the attest engagement partner; (b) directly supervises or manages the attest engagement partner, including all successively senior levels above that individual through the firm's chief executive; (c) consults with the attest engagement team regarding technical or industry-specific issues related to the attest engagement; or (d) participates in or oversees at all successively senior levels quality control activities, including internal monitoring, with respect to the specific attest engagement.

Indirect Financial Interest

An investment in which the specific investment decisions are not under the direct control of the investor.

Inherent Risk

The risk of material misstatement of a financial statement assertion, assuming there were not related controls. -In assessing this risk, it is useful to segregate transactions into three types-routine, non routine, and estimation

Presentation and Disclosure

Accounts are described and classified in accordance with generally accepted accounting principles, and financial statement disclosures are complete, appropriate, and clearly expressed.

Valuation, Allocation, and Accuracy

All transactions, assets, liabilities, and equity interests are included in the financial statements at proper amounts

Audit Evidence

Any information that corroborates or refutes the auditors' premise that the financial statements present fairly the client's financial position and operating results.

Substantive Procedures

Are designed to detect material misstatements of relevant assertions. These procedures include (a) analytical procedures and (b) tests of details of account balances, transactions, and disclosures

Risk Assessment Procedures

Are designed to obtain an understanding of the client and its environment, including its internal control, to assess the risks of material misstatement

Tests of Controls

Are designed to test the operating effectiveness of controls in preventing or detecting material misstatements

AR

Audit Risk

Independence Impaired For All Partners and Professional Employees If:

B. During the period of the professional engagement, a partner or professional employee of the firm, his or her immediate family, or any group of such persons acting together owned more than 5 percent of a client's outstanding equity securities or other ownership interests. C. During the period covered by the financial statements or during the period of the professional engagement, a partner or professional employee of the firm was simultaneously associated with the client as a: 1. Director, officer, or employee, or in any capacity equivalent to that of a member of management 2. Promoter, underwriter, or voting trustee 3. Trustee for any person or profit-sharing trust of the employee

Safeguards (to independence)

Controls that mitigate or eliminate threats to independence. -Range from partial to complete prohibitions of the threatening circumstance to procedures that counteract the potential influence of a threat.

CY

Current Year

Litigation

CPA's in litigation, or potential litigation, with a client must evaluate the situation to determine whether the significance of the litigation affects the client's confidence in the CPAs or the CPA's objectivity.

Threats (to independence)

Circumstances that could impair independence. The AICPA recognizes 7 types

Certified Valuation Analyst (CVA)

Confirm complicated items beyond CPA's knowledge like leases

Attest Engagement Team

Consists of individuals participating in the attest engagement, including those who perform concurring and second partner reviews. -Includes all employees and contractors retained by the firm who participate in the attest engagement, irrespective of their financial classification, except specialists and individuals who perform only routine clerical functions such as word processing.

CR

Control Risk

DR

Detection Risk

Corroborating Documents

Documents and memoranda included in the working papers that substitute representations contained in the client's financial statements. These working papers included audit confirmations, lawyers' letters, copies of contacts, copies of minutes of directors' and stockholders' meetings, and representation letters from the client's management.

Experienced Auditor

For purposes of audit documentation, an individual who has practical audit experience and a reasonable understanding of (1) audit processes; (2) Statements on Auditing Standards (SASs) and applicable legal and regulatory requirements; (3) the business environment in which the entity operates; and (4) auditing and financial reporting issues relevant to the entity's industry.

Confirmations

Generally effective at providing evidence about the assertion of existence of accounts, but they are less effective at addressing completeness and the appropriate valuation

Independence

Includes two concepts-independence of mind and independence in appearance

IR

Inherent Risk

Adjusted Journal Entries

Journal entries designed to correct misstatements found in a client's records

Control Risk

The risk that a material misstatement that could occur in an account will not be prevented or detected on a timely basis by internal control.

SOX Requirement Employment

One year must pass before a member of the audit team may accept employment with an SEC Registrant in certain designated positions

Least Reliable Evidence

PBCs

Working Papers

Papers that document the evidence gathered by auditors to show the work they have done, the methods and procedures they have followed, and the conclusions they have developed in an audit of financial statements or other type of engagement.

Rule 302

Pg. 88 Read Italics Only

PBC

Prepared By Client

Most Reliable Evidence

Prepared by external 3rd party

PY

Previous Year

PSRA

Private Securities Reform Act of 1995 • Includes a requirement for fraud reporting, or whistleblowing, by auditors

RJE

Reclassification Journal Entries

Covered Member

Refers to an individual, firm, or entity that is capable of influencing an attest engagement and includes: - An individual on the attest engagement team -An individual in a position to influence the attest engagement - A partner in the office in which the partner in charge of the attest engagement primarily practices in connection with the attest engagement -Certain partners or managers who provide nonattest services to the client -The public accounting firm, including its employee benefit plan -Any entity controlled by one or more of the above

RPT

Related Party Transactions

Timing of Analytical Procedures

Required at the risk assessment stage and near the end of the audit.

AICPA AU 580 (PCAOB 333)

Requires auditors to obtain a representation letter on every engagement and provides suggestions as to its form and content

AICPA Interpretation 101-3

Requires that while the CPAs should not perform management functions or make management decisions for the attest client, they may provide advice, research materials, and recommendations to assist the client. In such circumstances, the client must agree to: -assume all management responsibilities -oversee the service, by designating an individual, preferably within senior management, who possesses suitable skill, knowledge, and/or experience -Evaluate the adequacy and results of the services performed -Accept responsibility for the results of the services -Establish and maintain internal control, including monitoring ongoing activities

RMM

Risk of Material Misstatement

SALY

Same As Last Year

Interlocking

Serving on multiple committees within the board of directors

Negative Confirmation

Small paragraph sent to debtors in which they only respond if something is wrong.

External Standards

Standards that are imposed upon an individual by society, peers, organizations, employers, or his or her profession.

Current Files

The auditors' report for a particular year is supported by the working papers contained in this file.

Scanning

The auditors' use of professional judgment to review accounting data to identify significant unusual items that will be tested. -A type of analytical procedure

Independence in Appearance

The avoidance of circumstances that would cause a reasonable and informed 3rd party, having knowledge of all relevant information, including safeguards applied, to reasonably conclude that the integrity, objectivity, or professional skepticism of a firm or a member of the attest engagement team has been compromised.

Rights and Obligations

The company holds rights to assets, and liabilities are the obligations of the company

Documentation Completion Date

The date on which documentation should be completed. This is within 60 days of the delivery date.

Report Release Date

The date the auditor grants the client permission to use the auditor's report. This date is ordinarily close to the audit report date.

Second Partner Review

The purpose of this type of review is to provide assurance that all the CPA firm's in-house quality control policies have been complied with, as well as to provide a "second opinion" that the audit was performed in accordance with GAAS. -Sometimes called a quality review or cold review -Performed by a partner with no personal or professional ties to the audit client

Audit Risk

The risk that the auditors may unknowingly fail to appropriately modify their opinion on financial statements that are materially misstated.

Detection Risk

The risk that the auditors' procedures will lead them to conclude that a financial statement assertion is not materially misstated when in fact such misstatement does exist.

Independence of Mind

The state of mind that permits the performance of an attest service without being affected by influences that compromise professional judgment, thereby allowing an individual to act with integrity and exercise objectivity and professional skepticism.

Ethics

The study of moral principles and values that govern the actions and decisions of an individual or group.

Audit File

The unit of storage for a specific audit engagement. The audit documentation for each year's audit of a company is included in this file.

Gifts

The value of any gifts received by a CPA should be clearly insignificant to the recipient and reasonable in the circumstances.

Administrative Working Papers

Working papers specifically designed to help the auditors in the planning and administration of the engagement, such as audit programs, internal control questionnaires and flowcharts, time budgets, and engagement memoranda.

Positive Confirmation

sending out the actual amount the debtor owes the particular client and asking the debtor to verify the particular amount or to note exceptions (most successful way for auditors to get this info)

ACFE

audit committee financial expert -You would appoint someone ACFE if they have an accounting degree and work experience • However, those appointed are usually those who oversee the work of accountants