Auditing final Exam

internal controls involving fraud

-segragation of duties and responsibilities for transaction authorization, record keeping, custody of or access to assets, and reconciliation of actual assets to the accounting records +tone at the top and integrity by example and enforcement -management establishes committment to integrity and high ethical standards -accountability -codes of conduct -hiring and firing policies -background checks prior to hiring -prosecution of fraudsters

steps in sampling: planning

1. Determine the objective of sampling Drawing conclusion about some population of interest 2. Define the characteristic of interest question of interest to person conducting sampling plan 3. Define the population items about which question is asked need to ensure population is carefully and completely defined

Internal controls over cash

-dual custody of cash at all times -lockbox arrangement -fidelity bonds -EDI transaction (internet) -unused checks secured -check imprinting machine

some financial attestation engagements (other than audits)

-financial forecasts and projections-examination of managements discussion and analysis-pro forma financial information

characteristics of a fraudster

-has education beyond highschool -is likely to be married religious -ranges in age from teens to over 60 -is socially conforming -worked for company for 1-20 years -has no arrest record -usually acts alone

search for unrecorded liabilities

-inquire about procedures for identifying and recording liabilities -scan open purchase order file -examine unmatched vendor statements or invoices -examine unmatched recieving reports occurring near year-end -trace unpaid vouchers in accounts payable ledger to receiving reports -confirm account payable with normal suppliers -review cash disbursements occurring after year-end

factors affecting detection risk include

-nature, timing, and extent of audit procedures-Sampling risk - the risk of choosing an unrepresentative sample -no sampling risk: the risk that auditor may reach inappropriate conclusions based upon available evidence

audit cash receipts: process activities

-receive cash and remittance advice in mail -prepare remittance listing -enter total from remittance listing(or remittance advice) in cash receipts journal -prepare deposit slip and deposit cash receipts in bank (intact and daily) -record update to subsidiary A/R using remittance advice -reconcile remittance listing, subsidiary A/R, and deposit slip daily remittance listing = cash receipts journal = deposit slip and bank deposit = subsidiary ledger of A/R = bank statement

Inherent risks

- Improper Revenue Recognition Cut-off Bill and Hold Channel Stuffing - Returns and Allowances - Collectibility of Receivables

effectiveness losses

- Risk of over reliance (assessing control risk too low) - Risk of incorrect acceptance (audit-failure)

efficiency losses

- Risk of under reliance (assessing control risk too high) - Risk of incorrect rejection (over-auditing)

Auditing Accounts Receivable

- Test accounts receivable aged trial balance - Confirm Balances - Perform Analytical Procedures - Test Sales Cut-Off

factors affecting control risk include

- The environment in which the company operates (its "control environment"). - The existence (or lack thereof) and effectiveness of control activities. - Monitoring activities (audit committee, internal audit function, etc.).

attributes sampling

- Used to estimate the extent to which a characteristic exists within a population - Used in the auditor's study of internal control process: estimate the rate at which the clients internal control is failing to function effectively (ULRD) compare upper limit rate of deviation to an allowable level (tolerable rate of deviation)

negative confirmations

- the combined assessed level of inherent and control risk is low - a large number of small balances is involved - the auditor has no reason to believe that the recipients of the requests are unlikely to give them consideration

Materiality

-Quantitative Criteria §Absolute size §Relative size §Cumulative effects-Qualitative Criteria §Nature of the item or issue §Circumstances §Uncertainty Ultimately, materiality is a matter of professional judgment.

Risk of Material Misstatement

1.All inventory items have been included (completeness). 2.Inventory has been properly accounted and properly valued using an acceptable GAAP accounting method (valuation). 3.Items included in inventory on the balance sheet date (existence and cutoff). 4.Items included in inventory were the property of the client (rights). 5.Proper presentation and disclosures have been provided for inventory (presentation and disclosure) or footnotes. 6.Cost of goods sold includes all applicable materials, labor, and overhead properly valued (accuracy).

Analytical Procedure Steps

1.Develop expectations 2.Define a significant difference (both % and $) 3.Perform calculations 4. Investigate significant differences

Types of Audit Procedures

1.Inspection of records and documents -Vouching -Tracing -Scanning 2.Inspection of tangible assets 3.Observation 4.Inquiry 5.Confirmation 6.Recalculation 7.Reperformance 8.Analytical Procedures

The Standard (Unmodified) Report (Other Elements)

1.Title includes the word "independent" has to use the word independent 2.Addressed to the client (normally, shareholders and board) 3.Dated at the end of fieldwork when auditors have obtained sufficient appropriate evidence (date of the auditors' report) 4.Signed by the accounting firm (in the united states) internationally it is the audit partner

Types of Opinions

1.Unmodified/Unqualified opinion •F/S are in accordance with GAAP •Standard report may be modified to disclose additional matters 2.Qualified opinion •"Except for" some matter, F/S are in accordance with GAAP 3.Adverse opinion •F/S are not in accordance with GAAP 4.Disclaimer of opinion •No opinion is issued by auditors

Steps in sampling: performing

4. determine sample size 5. Select sample items ensure that all items are available for selection 6. measure sample items (based on characteristic of interest) perform procedure and make appropriate evaluation/measurement determine sample estimate (point estimate) non sampling risk may occur

Steps in sampling: evaluating

7. Evaluate sample results in statistical sampling, evaluating sample results control exposure to sampling risk parameters: sample estimate, precision, reliability

Control Risk

the likelihood that the client's internal control policies and procedures fail to prevent or detect a material misstatement

Audit Risk Model

AR = IR x CR x DR.

Audit risk model

AR = IR× CR× DR "set" AR is low or very low "assess" IR is HIGH if material misstatement is likely to enter the accounting information system "assess" CR is HIGH if material misstatement is not likely to enter the accounting information system Assess "IR and CR" forms "Risk of Material Misstatement (RMM)."calculate" DR is What is the acceptable level of detection risk? HIGH means we can afford less effective testing, LOW means we need more effective testing.

Accounting Estimates

Accounting estimates: •Examples include future cash flows in evaluating asset impairments, allowance for doubtful accounts for receivables, and depreciation lives for fixed assets •Review management's process for developing estimates •Review estimates for reasonableness

Control Over Accounting Estimates (AS 2501)

An accounting estimate is an approximation of a financial statement element, item, or account. Management is responsible for making these estimates. Some examples of topics where accounting estimates are used in the finance and investment cycle include: (1) depreciation, (2) financial instruments, (3) accruals, (4) leases, (5) interest rates, and (6) other such as losses, net realizable value on segment disposal and restructurings, and the impairment of goodwill. Auditors' tests of controls over the estimation process include making inquiries and observation (AS 2501 Auditing Accounting Estimates). Inquiries would include such questions as: •Who prepares estimates? •When are they prepared? •What data are used? •Who reviews and approves the estimates? •Have prior estimates been compared with subsequent actual events?

Statistical Sampling

Applies laws of probability in selecting sample items and evaluating sample results; -allows audit team to control exposure to sampling risk

Assurance Services

Assurance Services are "independent professional services that improve the quality of information, or its context, for decision makers." •eXtensible Business Reporting Language (XBRL) •Enhanced Business Reporting •Integrated Reporting •Trust Services (principles and related criteria in trust services engagements include: security, availability, processing integrity, confidentiality, and privacy) -WebTrust and SysTrust •Sustainability Reporting (corporate social responsibility)

Types of Attestation Engagements

Attestation engagements include those related to: •Agreed-upon procedures •Financial forecasts and projections •Pro forma financial information •An entity's internal control over financial reporting •Compliance attestation •Management's discussion and analysis •Service organizations

audit risk model

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Reports Accompanying Financial Statements

Auditor: (Nonpublic entities) Fairness of financial statements and related disclosures (Public entities) Fairness of financial statements and related disclosures Effectiveness of internal control over financial reporting Management: (Public entities) Effectiveness of internal control over financial reporting

Differences between audits and fraud examinations

Audits 1.Audit program 2.Procedural approach 3.Look for misstatements 4.Assess controls related to FS 5.Material misstatements 6.Accounting Theory 7.Evidence documented in audit documentation Fraud Audits 1.No set program 2.Procedures defined during investigation 3.Look for patterns 4.Evaluate how controls may be circumvented 5.Fraud is always material 6.Theories of psychology and human behavior 7.Safeguarding assets, recovering assets, and chain of custody for evidence

Government Auditing Standards—The Yellow Book

Audits must be performed in accordance with GAAS and Generally Accepted Government Auditing Standards (GAGAS) •As in a GAAS audit, a report on the fairness of the entity's financial statements is issued. •In a GAGAS audit, a report on the entity's compliance with laws and regulations is also issued.- •Illegal acts/fraud -Should be reported to the client unless they are clearly inconsequential. -May need to be reported directly to external parties.

bank reconciliation

Balance per bank -confirm directly with bank -agree amount to cutoff bank statement ADD deposits in transit -trace to cash receipts journal -vouch to cutoff bank statement SUBTRACT outstanding checks -vouch to cash disbursements journal -trace checks cleared from cutoff bank statement add/subtract other debit and credit memos -inspect bank credit/debit memo and audit for reasonableness balance per books -foot the entire reconciliation for mathematical accuracy -trace the amount to the trial balance

AICPA Code of Professional Conduct: Principles and Rules of Conduct

Basic tenets of ethical conduct are aspirational goals of behavior: •Responsibilities - exercise sensitive professional and moral judgment •Public Interest - honor the public trust •Integrity - perform responsibilities with the highest sense of integrity •Objectivity - impartial, unbiased, and independent, free of conflicts of interest and independent in fact and appearance •Due care - diligence, competence, thorough, prompt •Scope and nature of services - observe the principles when considering the scope and nature of services provided While Principles are aspirational goals of behavior, the Rules of Conduct are enforceable ethical regulations that CPAs must follow.

Internal Audit vs. External Audit

Basically- •External auditors audit financial statements •Internal Auditors audit business systems

Audit cash

Cash receipts journal cash disbursement journal bank reconciliations canceled checks bank statements

MUS -Overstatement errors are greatest concern -Standard deviation difficult to estimate -smaller number of misstatements anticipated -population has high degree of variability and large dollar components exist

Classical Variable Sampling -Both overstatement and understatement errors are of concern - standard deviation can be estimated -larger number of misstatements anticipated -population is homogenous and large dollar components do not exist

Risk of Material Misstatement

Common problems in the finance and investment cycle involve failures to record and disclose transactions and to appropriately adjust asset valuations for either changes in fair value on marketable securities or impairments. These problems can occur for a variety of reasons including: (1) complex transactions, (2) infrequent transactions , and higher amounts of estimation and judgment. Higher risk of material misstatement is present due to the following issues: •Complex transactions •Fair market value •Related-party transactions •Lease accounting •Loan covenants •Impairments •Presentation and disclosure

Reporting summary

Departure from GAAP Material: qualified Pervasive: adverse Scope Limitation Material: qualified Pervasive: disclaimer Audit of Group F/S Material: unmodified Pervasive: unmodified Other matters (consistency, going-concern, required supplementary, emphasis of matter, etc.) Material: unmodified Pervasive: unmodified Components modified/added intro: Scope Limitation (disclaimer) Auditors response: Scope Limitation (disclaimer), Audit of Group F/S Opinion: Departure from GAAP, Scope limitation, Audit of Group F/S Add'l: Departure from GAAP, Scope limitation, Other matters (consistency, going-concern, required supplementary, emphasis of matter, etc.)

Summary

Departures from GAAP Standard Report: Not material Qualified Opinion: material but not pervasive Adverse opinion: material and pervasive Scope Limitations Standard Report: Not material Qualified Opinion: material but not pervasive disclaimer of opinion: material and pervasive Audit of Group F/S Standard Report: assume responsibility for work of component auditors Unmodified Opinion: do not assume responsibility for work of component auditors

Derivative Investments, Hedging Activities, and Investments in Securities (AS 2503)

Derivative instruments are those that take their value from another asset or index (AS 2503 Audit Evidence—Specific Consideration for Selected Items). Recorded at fair value at the balance-sheet date. •Inquiries about the nature of investments and the reasons for holding them, especially hedging activities. •Classification affects the accounting treatment of market values and the unrealized gains and losses on investments. •Due to the complexity of Accounting for Derivative Securities and Hedging Activities, auditors may need special skills or knowledge to: -understand client hedging transactions -ensure that effective controls are in place -to audit the transactions.

Existence/Occurrence

Did the transaction take place? Do the account balances exist? Violation: false or fictitious recorded transactions. Ghost employees: fictitious employee going with fictitious accounts.

Effect of Factors on Sample Size

Direct: population size Direct: expected population deviation(expected misstatement) Inverse: tolerable rate of deviation(tolerable misstatement) Inverse: sampling risk Direct: population variability

Rights and obligations

Does the entity have the right to the assets and obligations to pay the liabilities? violations: rented asset recorded on the balance sheet; A/R that have been factored (these violations also impact existence)

Factors that affect inherent risk include:

Dollar size of the account Liquidity Volume of transactions Complexity of the transactions -New accounting pronouncements Subjective estimates

Comparison of Prospective and Pro Forma Engagements

Engagement Financial forecast: prospective information based upon future expected conditions, what will things look like if we continue along our expected path Financial projection: prospective information based upon hypothetical ("what-if?") events, what will things look like if we choose a different path pro forma: financial information based on historical information "as if" he event had previously occurred, what would things look like if the actual events occurred as of December 15th instead of January 15th.

Summary of Audit Communications

Engagement Letter (optional) From: auditors to: client Timing: Before engagement Method: Written Management Letter (optional) From: auditors to: client Timing: After Audit Method: Oral or written Written Representations (req) From: client to: auditors Timing: date of auditors report Method: written Attorney Letters (required) From: attorney to: auditors Timing: date of auditors report, should match Written Representation Method: Written

Audit Applications: Performance Auditing

Evaluating 1) the efficient and effective use of resources; 2) progress towards goals or objectives; and/or 3) results of a program are acceptable -Identification of performance criteria is critical and may be difficult

Audit Applications: Financial Audits

Examine and evaluate •Areas of management concern (e.g. new payment process) •Financial information used by internal decision makers (e.g. monthly sales reports) •Financial information being sent to outside agencies (e.g. regulatory agencies)

PCAOB Assertions

Existence or occurrence- assets and liabilities included in the accounts exist and recorded transactions are valid and have actually occurred Rights and Obligations- entity has a legal claim on all assets and revenues reported and has a legal responsibility for all liabilities and expenses Completeness- all balances and transactions have been recorded in the financial statements Valuation and allocation- Assets, liabilities, and recorded transactions have been valued in accordance with GAAP Presentation and disclosure- all accounts are presented in the appropriate place and all information required has been disclosed in the statements and footnotes.

Finance and Investment Functions

Financing the Entity through Debt and Stockholder Equity 1.Financial Planning 2.Raising Capital -Record keeping for long-term liabilities -Periodic reconciliation 3.Investing Transactions: Investment and Intangibles -Authorization -Custody -Record keeping for investments -Periodic Reconciliation

Government Auditing Standards—The Yellow Book (continued)

In addition to the audit of the entity's financial statements, an examination of a governmental entity introduces the following considerations for the auditor's consideration: -Compliance with Laws and Regulation -Effectiveness of the Entity's Internal Control -Compliance with the Specific Requirements of Individual Federal Financial Assistance Programs -Compliance with Requirements Applicable to All Federal Financial Assistance Programs

Internal Auditing Defined

Internal auditing is an independent, objective, assurance and consulting activity designed to add value and improve an organization's operations. It helps an organization accomplish its objectives by bringing a systematic, disciplined approach to evaluate and improve effectiveness of risk management, control, and governance processes.

Internal Audit

Key elements to successful internal audits: •Value Added •Proactive - look for future problems and opportunities •Creative - find new ways to do things •Customer-focused ü Talk to departments and managers about their issues •Utilizes all business perspectives ü Understand the business •Understand the management process. Where are decisions made

Fair Market Value Measurement Hierarchy

Level 1: Fair values are derived from quoted market prices for identical assets or liabilities from an active market to which an entity has immediate access Level 2: Market prices are available for similar (as opposed to identical) assets or liabilities Level 3: if values for levels 1 or 2 are not available, fair value is estimated using valuation techniques

Control Risk Categories (Qualitative)

Low control risk Moderate control risk Control risk slightly below the maximum Maximum control risk

Risk of incorrect acceptance

Occurs when -sample indicates account is not misstated -account is misstated result -effectiveness loss -audit failure

Fraud Diamond

Pressure, Opportunity, Rationalization, Capability

Retained earnings

Relevant assertions Completeness

Investments

Relevant assertions Existence/occurrence completeness valuation presentation and disclosure

long term debt

Relevant assertions Existence/occurrence completeness valuation presentation and disclosure

Capital Stock

Relevant assertions completeness presentation and disclosure

Sampling risk

Risk that a sample is not representative of the population. caused by selecting a nonrepresentative sample

Roll-forward Procedures

Roll-forward procedures: Extend work from interim period to date of the financial statements •Include both tests of controls and substantive procedures •Performed following date of the financial statements •Idea is to obtain evidence through the date of the financial statements

controls related to revenue

Separation of duties -separate functions for recording, authorization, custody Authorization of transactions -write-offs -EDI transactions -Credit checks prior to approval of sale(rare) Pricing Access to assets -shipping department -lockbox account Adequate documents and records -pre-numbered sales orders, shipping documents(bills of lading), sales invoices -remittance advice independent checks of performance -A/R subsidiary ledger to general ledger -monthly statement to customer

Revenue Recognition

Step 1: identify the contract with the customer Step 2: identify the separate performance obligation Step 3: determine the transaction price Step 4: allocate the transaction price to the separate performance obligations Step 5: recognize revenue when performance obligations are satisfied

Audit Applications: Operational Audits

Term is sometimes used synonymously with internal audit. Examine and evaluate: •Current risks that need to be managed •Possible future risks •Internal control •Quality, effectiveness, and efficiency of performance

Audit Procedures‒Economy, Efficiency, and Program Results Audits

The GAO establishes GAGAS that guide all audits for federal government agencies and facilities and all audits of entities receiving federal funds. A sample of this literature includes the following: •Single Audit Act of 1984 •OBM Circular A-133 •OMB Circular A-122 •OMB Circular A-110 •OMB Circular A-102 •OMB Circular A-87 •OMB Circular A-21 •AICPA Audit and Accounting Guide

Audit Applications: Corporate Governance

The board of directors and senior management must have reliable and relevant information to meet their responsibilities •Management policies are in effect •Strategy decisions are made with the best information •Adequate progress toward goals •Operating performance is measured and communicated •Risk assessment is performed and communicated •Effectiveness of proactive risk management

Audit Applications: Compliance Audits

The degree the organization conforms to specific requirements •Policy and procedures •Professional standards •Laws, regulations, or contracts The audit focuses on the detailed testing of existing conditions and compares them to requirements.

business risk

The risk that an entity will fail to meet its stated business objectives i.e. go bankrupt

Information Risk

The risk that the information disseminated by a company will be materially false or misleading -users demand an independent third party(auditor) assessment of the information

employee fraud

The use of fraudulent means to take money or other property from an employer. It consists of three phases: (1) the fraudulent act, (2) the conversion of the money or property to the fraudster's use, and (3) the cover-up.

Completeness

Were all transactions recorded in the accounting system? are account balances complete? Violation: valid transactions not recorded.

Fraud Examinations

Who performs a fraud examination (sometimes called a fraud audit)? •Internal audit •Independent auditors •Security •Certified Fraud Examiners •Combination working as a team

Bank cutoff statement

a bank statement as of a date subsequent to the date of the balance sheet. The date should be at a point in time that will permit most of the year-end outstanding checks to clear the bank.

attestation engagement

a practitioner assesses and reports on "subject matter or an assertion about the subject matter that is the responsibility of another party"

classification

are account classifications accurate violations: improper classification of current vs. noncurrent assets or liabilities; improper classification of investments.

assurance services

are independent professional services that improve the quality of information, or its context, for decision makers.

valuation

are the accounts valued according to GAAP? violations: failure to record depreciation; improper valuation of investments; failure to account for bad debt.

direct-effect illegal acts

are violations or government regulations by the company, or its management or employees that produce direct and material effects on dollar amounts in the financial statements.

internal controls over cash

cash is highly liquid, easily transportable, not easily identifiable which makes it primary target for employee thieves.

Nonsampling risk

the likelihood that an incorrect conclusion will be reached because of reasons unrelated to sampling

nonstatistical sampling (used more than statistical)

does not allow audit team to control exposure to sampling risk -both statistical sampling and nonstatistical sampling are appropriate under GAAS.

Employee Fraud Red Flags

experience sleepiness -drinking too much -take drugs -become irritable easily -cant relax -get defensive -cant look people in the eye -sweat excessively -go to confession - find excuses and scapegoats for mistakes -work alone -work late frequently -don't take vacations

expenditure cycle frauds

improperly capitalized expenses off-balance sheet liabilities

voucher packet

includes (Purchase requisition, purchase order, receiving report, invoice) matched prior to cash disbursement authorization

documentation

involves all seven steps of sampling process important judgements include: -factors affecting sample size -method of selecting sample and summary of items selected -method of measuring sample items and summary of measurements -evaluation of sample results and overall conclusion

presentation and disclosure

is the financial statement presentation according to GAAP? are disclosures sufficient? the assertion largely relates to the sufficiency of footnotes violation: insufficient or incomplete footnotes

Selecting sample items

methods Unrestricted random selection: select items based on random numbers matched to items in population Systematic random selection: bypass a fixed number of items in population selecting every nth item block selection: select contiguous units haphazard selection: select items in a nonsystematic manner

risk of overreliance

occurs when -sample indicates controls are functioning effectively -controls are not functioning effectively result? -auditors conclude that controls are functioning effectively -effectiveness loss (do not reduce audit risk to sufficient level) -under-auditing

risk of underreliance

occurs when -sample indicates controls are not functioning effectively -controls are functioning effectively result? -auditors conclude that controls are not functioning effectively -efficiency loss (perform more effective substantive procedures than necessary) -over-auditing

Sarbanes-Oxley Act 2002

only applies to publicly traded companies(issuers)

Fraud Triangle

opportunity, financial pressure (motivation), rationalization

Precision and reliability

precision(allowance for sampling risk): distance from the estimated population value in which the true but unknown population value may lie with a given probability Reliability(confidence): likelihood of achieving a given level of precision steps: based on sampling procedure, form sample estimate based on precision and reliability, form precision interval

Accounts Receivable confirmations

primarily for verifying existence factors likely to affect the reliability of confirmations -previous audit experience -intended recipient of the confirmation -type of information being confirmed auditor may confirm entire balances or individual transactions -type of confirmation being sent

AICPA Code of Professional Conduct

principles: Ideal standards of ethical conduct, rules of conduct: •Minimum standards of ethical conduct stated as specific rules, interpretations: •Interpretations of the rules by the AICPA division of professional ethics, ethical rulings: Published explanations and answers to questions about rules of Conduct

Public Company Accounting Oversight Board (PCAOB)

regulate auditors of publicly traded companies

Detection Risk

the likelihood that the auditors' substantive procedures will fail to detect a material misstatement that exists within an account balance or class of transactions

Analytical Procedures

sales revenue -comparisons with previous periods -comparisons with industry allowance for doubtful accounts, bad debt expense -bad debt expense as a percentage of sales -allowance for doubtful accts as a percentage of gross receivables A/R -days sales in A/R -A/R turnover

Blank Confirmation

should be used if the recipient is likely to return a positive confirmation without verifying the accuracy of the information

Positive confirmations (most common)

small number of accounts are involved large number of errors are anticipated

Sampling

the process of making a statement about and population of interest by examining only a subset (or sample) of that population

errors

the unintentional misstatements or omissions of amounts or disclosures in financial statements

Errors

the unintentional misstatements or omissions of amounts or disclosures in financial statements Errors are not considered fraud because they occur unintentionally, while acts of fraud are intentional. Other fraud-related definitions include:•Employee fraud is the use of fraudulent means to misappropriate funds or other property from an employer.

Variable Sampling

used to estimate the amount (or value) of a population substantive procedures -estimate account balance or misstatement. -compare estimated account balance or misstatement to recorded balance or tolerable misstatement.

accuracy

were transactions recorded at the proper amount? violations: inaccurately recording a dollar amount violation example: recording an entry for $5055 instead of $5505.

Cut-off

were transactions recorded in the proper period? Violation: end-of-period transactions recorded in the wrong period.

Ratio Estimation calculations

•1. Calculate ratio for the sample: Audited Sample Bal/Book Sample Bal •2. Multiply Sample Ratio by the Book Balance.

Mean-per-unit calculations

•1. Find the average account balance for the audited sample •2. Multiply the average account balance by the number of total observations

Auditing Stock-Based Compensation Plans

•ASC 718 requires that employee stock-based compensation must be recorded using a fair value-based method at the date the award is granted and must be credited to paid-in-capital and expensed over the compensation period. •Often involves the application of complex option pricing models and, as a result, auditing stock-based compensation can be a risky area. •Requires appropriate allocation between common stock and paid-in-capital accounts upon exercise. •Auditors must follow the standards for auditing accounting estimates (AS 2501) and auditing fair value estimates (AS 2502).

Decisions under MUS

•Account balance is not misstated -Suggest correction of identified misstatements -Investigate cause of misstatements •Account balance is misstated -(LOW) Increase sample size to attempt and reduce upper limit on misstatements -(HIGH) Recommend adjustment to reduce misstatement below tolerable misstatement

Adjusting Entries and Financial Statement Disclosure

•Accumulate dollar effects of identified misstatements •Evaluate materiality -Rollover method considers the current period income effect(s) of misstatements -Iron curtain method considers the aggregate effect of the adjustments on the entity's balance sheet -SAB 108 requires adjustments to be proposed if material under either approach •Recommend adjustment of all misstatements identified •Carry any uncorrected misstatements forward for consideration in future audits •Communicate all adjustments and misstatements to audit committee or individuals charged with governance

Consistency: Effect on Report

•Add emphasis-of-matter paragraph following the opinion paragraph •May issue a qualified opinion (GAAP departure) if: -Change is not justified -Change is not accounted for in accordance with GAAP

Substantive Tests of Interest-Bearing Liabilities (IBL)

•Agree to beginning balance and confirm with holders or makers •Loan Proceeds (cash coming in from loans) -Vouch to cash receipts to cash journal and bank statement -Recalculate Discount/Premium -Confirm IBL and examine note •Loan Payoff -Recalculate Interest Expense -Recalculate Gain/Loss on Retirement -Vouch to cash disbursements journal and bank statement -Confirm with debt holder if necessary (rare)

Analytical Procedures

•Analytical procedures: Study of relationships among financial and nonfinancial data -Can be used in planning (required), substantive testing, and near the end of the audit (required) -Near the end of the audit, analytical procedures identify unusual or unexpected relationships not previously identified •Review accounts for "miscellaneous," "other," and "clearing" accounts (may relate to earnings management)

Audit Documentation Review

•Audit supervisor -Have all steps in audit plan been performed? -Is referencing among documentation clear? -Are explanations understandable? •Audit manager and partner -Is the overall scope of the audit adequate? -Do overall conclusions support the opinion? •Reviewing partner -Is the quality of audit work and reporting consistent with quality standards of the firm? -Engagement quality review

Going-Concern Uncertainties

•Auditors are responsible to evaluate whether substantial doubt exists about ability of entity to continue in existence for one year beyond date of F/S •Options -Add emphasis-of-matter paragraph following opinion paragraph (still unmodified opinion) -If serious uncertainty, may issue disclaimer of opinion -Modified language must include the words: SUBSTANTIAL DOUBT & GOING CONCERN

Association with Unaudited Financial statements

•Auditors permit use of name in communication including F/S •Issue disclaimer of opinion (one paragraph) -Do not mention auditing procedures performed -Must identify any known departures from GAAP in the report -Should cover all unaudited prior years' financial statements

Ability to Continue as a Going-Concern

•Auditors required to consider whether evidence obtained during audit raises questions about ability to continue as a going concern •If concerns exist, evaluate management's plans to mitigate -If concerns do not remain: No effect on report or financial statements -If concerns remain: Disclose in F/S and modify auditors' report

Audit Procedures for Obtaining Audit Evidence

•Auditors use audit procedures for three purposes including: -To gain an understanding of the client and the risks associated with the client (risk assessment procedures). -To test the operating effectiveness of client internal control activities (test of controls). -To produce evidence about management's assertions related to the amounts and disclosures in a client's financial statements (substantive procedures).

Communication with Individuals Charged with Governance

•Auditors' responsibility under GAAS •Overview of planned scope and timing of audit •Judgment about quality of accounting policies, estimates, and disclosures •Significant difficulties encountered during audit •Uncorrected misstatements Disagreements with management Material, corrected misstatements Representations requested from management Management consultations with other auditors Significant issues discussed with management Auditor's understanding of significant unusual transactions Other findings or issues significant and relevant to those charged with governance

ABC has an A/P balance of $100,000 comprised of 130 vendors. The auditor selects 20 items for testing. The total audited balance of the sample is $14,980. If the auditor can tolerate a 7% error of the balance and the confidence interval is +/- 4,000, would the auditor conclude the balance is fairly stated?

•Ave sample balance: 14,980/20 = $749 •$749 * 130 = $97,370 •$97,370 +/- $4,000 = $93,370 - $101,370 •Tolerable error: 7% * 100,000 = $7,000 •Decision: Accept the Sample

Long-Term Liabilities and Related Accounts

•Balance-sheet assertions of completeness and presentation and disclosure •Unrecorded liabilities must be tested •Confirmations sent to lenders to verify long-term liabilities •Interest expense may be estimated by analytical procedures •Confirmations and inquiry procedures for off-balance-sheet commitments (loan agreements, leases, endorsements, guarantees, and insurance policies) and contingencies

Prosecuting Fraud Perpetrators

•Building a fraud case •Protecting the evidence including the chain of custody of evidence, interviews, interrogations, confessions, documents obtained by subpoena, and other matter) •Obtaining litigation support

Overview of Types of Frauds

•COMPANY-Customers §False Advertising §Short Shipments §Defective Products §Price Fixing §Shoplifting §False Refunds §False Credit Cards §Hot Checks-Government §Tax Evasion §Contract Cost Padding §False Benefit Claims-Insurers §False Loss Claims-Employees §Expense Account Padding §Embezzlement §Theft of Cash and Property §Kickbacks §False Benefits Claims §Padded Payroll-Vendors/Suppliers/Consultants §Short Shipment §Double Billing §False Invoices §Employee Bribery-Competitors §Theft of Trade Secrets §Employee Bribery-Stockholders/Creditors §Fraudulent Financial Statements §Securities Fraud-Owners/Managers § Insider Trading § Related-Party Transactions

Emphasis of a matter

•Call user attention to important matters •Add emphasis-of-matter paragraph after opinion paragraph discussing the matter

Type of Scope Limitations

•Circumstance-Imposed -Situation in which matters beyond auditors' and client's control limit procedures performed by auditors -Example: inability to observe year-end inventory because of late appointment •Client-Imposed -Situation in which client specifically limits auditors' procedures -Should be viewed as a significant restriction and a disclaimer is ordinarily issued

Procedures Performed During Fieldwork

•Completing substantive procedures •Attorney's letters •Written representations •Going-concern assessment •Adjusting entries •Audit documentation review •Subsequent events •Subsequently discovered facts

Finance and Investment Cycle: Typical Activities

•Concerned with transactions related to the use of the organization's funds (investing) and sources of those funds (financing) other than operations. •Includes accounts and records across tangible and intangible assets, long-term liabilities, deferred credits, stockholders' equity, gains and losses, expenses, and income taxes. •Accounts include some of the more complicated topics in accounting: equity method accounting for investments, consolidation accounting, goodwill, income taxes, and derivatives.

Additional Considerations in Classical Variables Sampling

•Consider the following additional factors in determining sample size -Risk of incorrect rejection -Population variability •To reduce population variability, auditors may choose to stratify the population

Agreed-Upon Procedures Engagements

•Consists of performing procedures normally associated with an audit or special engagement -Inventory observation -Confirmation of receivables -Summarize customer comment cards •Scope less than in an audit (responsibility of user) •Accountant reports procedures and findings -No opinion or negative assurance provided Must restrict distribution of report to users who established scope of

Comparative Financial Statements

•Continuing auditors -Report should address all years presented in comparative form -Update opinion by considering if previously issued opinions still appropriate -If previously issued opinions not appropriate, revise opinion in current report (other-matter paragraph) •Predecessor auditors -With permission, auditors may present reissued report from predecessor on prior years' F/S along with successor's report on current F/S -If predecessors' report not presented, successor auditors' report must reference predecessors' report and opinion on prior years' F/S (other-matter paragraph)

Audit Applications: Sustainability Audits

•Corporate social responsibility •Auditors may assist -Governance -Ethics -Environmental issues -Health, safety, and security -Human rights and work conditions -Establishing a sustainability program -Establishing measurement criteria -Establishing reporting processes -Monitoring the sustainability reporting process

Monetary Unit Sampling (MUS)

•Defines the sampling unit as an individual dollar (or other monetary unit) in an account balance •Auditor will select individual dollars (or monetary units) for examination •Auditor will verify the entire "logical unit" containing the selected dollar (or monetary unit) -Accounts receivable: Customer account -Inventory: Inventory item

Summary Financial Statements

•Derived from the full set of financial statements •Auditor can only examine and report if audited full financial statements •Report -Refers to auditors' report on full financial statements -Indicates whether information in summary financial statements is consistent in relation to the full financial statements

MUS: Evaluating Sample Results

•Determine the upper limit on misstatements, which has a (1 - Risk of incorrect acceptance) of equaling or exceeding the true amount of misstatement •Components: -Projected misstatement -Incremental allowance for sampling risk -Basic allowance for sampling risk

Classical Variables Sampling Approaches 2/3

•Difference estimation: -Assumes each item in population (component of account) has similar difference between recorded and audited value -Estimates the amount of misstatement by multiplying number of components by average misstatement -Estimates recorded balance using estimated misstatement

Compilation Engagements

•Do not have to include footnotes. •Accountants do not have to be independent. •No assurance provided. •The date of completion is the date of the accountant's report. •Each page of the compiled financial statements should include: "SEE ACCOUNTANTS' COMPILATION REPORT".

Role of the Internal Auditor

•Ensure reliability and integrity of information •Safeguard assets •Ensure compliance with policies and regulations •Foster the achievement of organizational objectives and goals •Improve operational economy and efficiency •Identify areas of business risk •Help prevent and detect fraud •Coordinate audit activities with external auditors

Types of Attestation Engagements—Levels of Assurance

•Examination -Similar to an audit -High level of assurance •Review -Moderate ("negative") level of assurance -Not allowed on certain engagements •Agreed upon procedures -Assurance depends on procedures

Compliance Attestation (AT 601)

•Examples -dividend limitations -loan limitations -prescribed debt/equity ratios -limitations on geographic operations •Examinations made in conjunction with financial statement audits

Types of Audits (Internal Auditors)

•Financial Audits •Compliance Audits (compliance with policies, procedures, laws, and regulations) •Operational Audits •Governance Audits •Other Audits (quality control audits, environmental audits, sustainability audits)

Review of Interim Financial Information

•Financial information that covers a period ending on a date other than the entity's fiscal year end. •SEC companies are required to have a review of the interim financial information filed with the SEC. •Need to gain sufficient knowledge of the entity's business and internal control. •May have a report on interim financial information -Separate from the audited financial statements. -Presented as a supplement to audited financial statements.

Governmental Reporting

•GAGAS usually have three sets of reporting standards: -Financial audits -Attestation engagements -Performance audits

Effect on Report

•Group auditors should -Verify component auditors' reputation and independence -Communicate and coordinate with component auditors •Options -Take responsibility for work: Standard (unmodified) report -Name component auditors •Present report of component auditors, only with their permission -Refer to component auditors •Modify Auditor's Responsibility section •Modify opinion paragraph •Still express unmodified opinion, if appropriate

Audit of Group Financial Statements

•Group financial statements: Financial statements comprised of more than one division/subsidiary/segment/component •Group auditors: Conduct audit of material portion of the entity •Component auditors: May be engaged by group auditors to audit divisions, subsidiaries, or components

Subsequently Discovered Facts

•If discovered prior to audit report release date, perform procedures related to items -Revise date of auditors' reports to reflect new completion date -Dual date auditors' reports •Following audit report release date: If facts would result in revision of auditors' report or F/S and individuals are relying on F/S -Notify individuals relying on F/S -Issue revised F/S which provide disclosure of facts

Internal Audit Reports

•Include both favorable or unfavorable findings •Unfavorable findings should include -Condition - what was found -Criteria - basis for determining that the condition was improper -Cause - why did this happen? -Effect - why is this bad? -Recommendation - what do you think should be done about this?

Reports on Elements of Financial Statements (AU 805)

•Independent auditors may be requested to express an opinion on one or more specified elements, accounts, or items of a financial statement. •GAAS audit performed. •Report similar to audit report -Instead of financial statements, specified elements, accounts, or items are audited. -Auditors express an opinion on whether the account, element, or item is fairly stated in accordance with the appropriate framework. •If adverse opinion or disclaimer is issued for the financial statements taken as a whole, the auditors may not accept engagement (i.e., the auditors may not reduce scope of service).

Contents of Written Representations

•Information related to financial statements -Management's responsibility for F/S and internal control over financial reporting -Appropriate disclosure, presentation, and reasonableness of items -Statement that uncorrected misstatements are immaterial •Information provided to auditors by management •Internal control over financial reporting (for public entities)

Procedures for Litigation, Claims, and Assessments

•Inquiry of clients •Review minutes of meetings of stockholders, directors, and committees •Review contracts, loan agreements, and correspondence from taxing and governmental agencies •Obtain information concerning guarantees from bank confirmations •Review documentation related to legal services •Attorney's letters

Components of the Standard (Unmodified) Report

•Introductory paragraph -F/S and years examined •Management's Responsibility section -Management responsible for financial statements -Management responsible for internal control •Auditor's Responsibility section -Auditor responsible for issuing opinion on financial statements -Audit conducted in accordance with GAAS -Audit provides reasonable assurance •Opinion -Are F/S presented in accordance with applicable financial reporting framework (GAAP)?

General Approach for Other Matters

•Issue unmodified opinion but add paragraph to report to discuss the matter -Emphasis-of-matter paragraphs provide information related to users' understanding of F/S -Other-matter paragraphs provide information related to users' understanding of audit, auditors' responsibility, or auditors' report •Situations -Consistency -Going-concern -Other Information -Required Supplementary Information -Emphasis of a matter

Adverse Opinion

•Issued when F/S do not present fairly according to GAAP (i.e., a serious, pervasive departure from GAAP). •Report Modifications: -Add paragraph preceding the opinion paragraph explaining the departure and detailing $ amounts involved -Change opinion paragraph ("financial statements do not present fairly")

Qualified Opinion

•Issued when departure is material, yet not pervasive •Report Modifications: -Add paragraph preceding the opinion paragraph explaining departure and detailing $ amounts involved -Modify opinion paragraph ("In our opinion, except for the matter discussed in the preceding paragraph,....")

Scope Limitation: Qualified Opinion

•Issued when scope limitations are material, but not pervasive •Report Modifications: -Add paragraph preceding the opinion paragraph describing the scope limitation -Modify opinion paragraph ("In our opinion, except for")

Management Discussion and Analysis(AT 701)

•Management Discussion and Analysis (MD&A) accompanies audited financial statements in the annual report. •Auditors are required to read the MD&A to ensure that information is consistent with the audited financial statements. •Auditors may accept an engagement to perform an examination or review of the MD&A.

Auditing Fair Value Measurements (AS 2502)

•Management has primary responsibility for determining fair value of assets and liabilities in accordance with GAAP •Use of fair value for measurement of transactions and disclosure, with more stringent determination and disclosures for investments, derivatives, and other assets and liabilities •A fair value measurement hierarchy has been established •Substantive procedures for auditing accounting estimates include (AS 2502 Auditing Fair Value Measurements and Disclosures): -use of acceptable valuation principles -valuation principles consistently applied -valuation principles supported by documentation, and -method of estimation and significant assumptions properly disclosed

Classical Variables Sampling Approaches 1/3

•Mean-per-unit: -Assumes each item in population (component of account) has similar balance -Estimates recorded balance by multiplying number of components by average audited value

Examination of an Entity's Internal Control over Financial Reporting (AT 501)

•Necessary Conditions -Management accepts responsibility -Management's evaluation of control is based on suitable and available criteria -Management's evaluation of control is supported by sufficient evidence -Management presents its assertion in a written report that accompanies the auditors' report

Management Letters

•Not required under GAAS •Are prepared as a by-product of procedures performed in audit •Provide recommendations to client for improving effectiveness and efficiency of operations •Delivered by auditors to client following audit engagement

Procedures to Identify Subsequent Events

•Obtain understanding of procedures management performs to identify subsequent events •Inquire of management and those charged with governance •Read minutes of meetings of owners, management, and those charged with governance •Review entity's interim financial statements

risk of incorrect rejection

•Occurs when -Sample indicates account is misstated -Account is not misstated •Result? -Auditors conclude that account is misstated -Auditors perform additional procedures -Efficiency loss (perform more effective substantive procedures than necessary) -Over-auditing, possible unnecessary adjusting journal entry

Non-Financial statement Information

•Other Information Accompanying F/S -Auditors required to ensure information consistent with F/S -If not consistent, either revise opinion on F/S or add emphasis-of-matter paragraph •Required Supplementary Information -Auditors required to perform limited procedures and expand report on F/S to address -Add other-matter paragraph to identify information, describe procedures performed, and identify any issues

Omitted Procedures (rare)

•Perform procedures if: -Omitted procedures are important -Individuals are currently relying on financial statements and auditors' reports •If previous opinion can be supported, no further action necessary •If previous opinion cannot be supported -Withdraw the original report -Issue revised reports -Inform persons currently relying on the financial statements

Nonstatistical Sampling

•Permissible under GAAS •Does not permit auditors to control exposure to sampling risk •Major differences in: -Determining sample size -Selecting sample items -Evaluating sample results

Scope Limitation: Disclaimer of Opinion

•Pervasive scope limitation, usually client-imposed -Significance of the limitation is such that auditors cannot gather sufficient appropriate evidence to form an opinion •Report Modifications: -Introductory paragraph: ("We were engaged to audit ....") -Modify Auditor's Responsibility section: •Note that auditors were not able to obtain sufficient appropriate evidence •Delete paragraphs describing an audit and indicating that the audit provides a basis for the opinion -Add paragraph preceding the opinion paragraph describing the scope limitation -Modify opinion paragraph ("...we do not express an opinion....")

Use of Analytical Procedures

•Planning phase - REQUIRED •Substantive phase - Optional •Final wrap-up phase - REQUIRED

Financial Forecasts and Projections (AT 301)

•Prospective Financial Information (PFI) -Financial information representing the financial position, results of operations, and cash flows for some period of time in the future. •Types of PFI -Financial projection: PFI based on the occurrence of one or more hypothetical events that change existing business structure. -Financial forecast: PFI based on expected conditions and courses of action (e.g., no new distribution center). •The company may be negotiating directly with a single user who has requested prospective financial information for use in economic decisions. -This is referred to as limited use. -Any PFI can be used for limited purposes. •The company may be preparing prospective financial statements that it intends to present to a large number of users, none of whom it is negotiating with at the current time.

Types of Subsequent Events

•Provide new information about conditions existing at date of the financial statements -Adjust financial statements to reflect new information •Involve events that arose following the date of the financial statements -Disclose in financial statements

Written Representations

•Provided by management to auditors •Dated using date of auditors' reports (audit completion date) •Broad purpose -Impress upon management its primary responsibility for the financial statements -May establish auditors' defense if a question related to inquiries subsequently arises •Qualify or disclaim an opinion if not provided by the client

Disadvantages of MUS

•Provides a conservative (higher) estimate of misstatement •Not effective for understatement or omission errors -Liabilities and expenses •Expanding sample is difficult if initial conclusion is to reject the account balance

Classical Variables Sampling Approaches 3/3

•Ratio estimation: -Assumes a constant percentage misstatement in population -Estimates recorded balance by multiplying recorded balance by ratio of audited value to recorded balance

ABC has a $200,000 A/P balance comprised of 180 vendors. The auditor selects 25 items for testing. The unaudited balance of the sample is $28,500 and the audited balance is $27,770. If the auditor can tolerate a 7% error of the balance and the confidence interval is +/- 5,000, would the auditor conclude the balance is fairly stated?

•Ratio: 27,770/28,500 = .97439 •.97439 * 200,000 = $194,877 •$194,877 +/- 5,000 = $189,877 - $199,877 •Tolerable error = $14,000 error •Accept the Sample

Consistency

•Relates to: -Change in accounting principles -Adjustments to correct misstatements in previously issued F/S •Type of changes in accounting principles: -Accounting principles (GAAP to GAAP) or (LIFO to FIFO) -Form of reporting entity -Accounting principles (non-GAAP to GAAP) -Accounting principle inseparable from changes in estimates

Attestation Engagements

•Report on subject matter or assertion about subject matter •Responsibility of another party •Responsible party—acknowledge responsibility

Reporting on Pro Forma Financial Information (AT 401)

•Reporting "AS IF" a transaction had occurred by a specific date (retrospectively) •Basic engagement objectives -Management's assumptions on significant effects of transactions are reasonable -Management's assumptions are properly reflected in pro forma adjustments -The adjustments are properly made in the pro forma results

Review Reports

•Reports should include -Statement that information is representation of management. -A description of the scope of a review engagement -Level of assurance provided --Moderate assurance. -The date of completion should be used as the date of the accountant's review report. -Each page of the Financial Statements reviewed should include: "SEE ACCOUNTANTS' REVIEW REPORT".

Special Purpose Frameworks (SPFs) (AU 800)

•Types of bases that may be used -Statements conforming to regulatory agency accounting rules -Basis used for income tax purposes -Cash basis or Modified cash basis -Some other method required for contractual purposes •A GAAS audit is still performed •Limited distribution

Single Audit Act of 1984 and Amendments of 1996

•Required for entities who receive specified levels of financial assistance from the federal government. •Requires the auditor to issue the same reports as those issued in a Government Auditing Standards audit: -Opinion on financial statements -Compliance with laws and regulations -The auditor issues an opinion on Compliance with the Specific Requirements of nonmajor programs -Auditor's report on Compliance with the General Requirements

Advantages of MUS

•Results in more efficient (smaller) sample sizes •Selects transactions or components reflecting larger dollar amounts •Effective in identifying overstatement errors -Asset and revenue accounts •Generally simpler to use than classical variables sampling

Review Engagements

•Review engagement procedures: -Written engagement letter -Understanding of the client's business -Analytical procedures -Inquiry of management -Written management representations •Review documentation must include: -Analytical procedures -Procedures used in response to results of analytical procedures -Inquiries -Unusual matters considered in the engagement -Written representations

Unaudited Financial Statements

•Reviews—moderate (negative) assurance •Compilations—no assurance •Statements on Standards for Accounting and Review Services (SSARs) from the AICPA's Accounting and Review Services Committee

Audit Approach

•Risk-based auditing (RBA) -Placing audit resources where the greatest risks exist •Fieldwork in internal (and governmental) audits -Problem identification -Measurement criteria -Evidence collection -Evidence evaluation •Emphasis on management and mitigation of business risk

Typical Activities

•Sales Forecasts •Production Planning -Production plan •Production and Inventory Control -Bill of materials -Requisitions •Cost Accounting -Standard costs Overhead allocation

Lack of Independence

•Scenario: Auditors begin engagement but independence subsequently compromised •Report -Single paragraph -Indicates auditors are not independent -Does not indicate why independence lacking

Why Develop New Assurance Services?

•Shift from the industrial age to the knowledge area •Information technology •Globalization •Demands for transparency and new focus on corporate governance •New social structures

Special Reports

•Special reports refers to auditors' reports issued in connection with the following: -Specified elements, accounts, or items of a financial statement -Financial statements that are prepared in conformity with a special purpose framework (SPF) -Reporting on the requirements of appropriate financial reporting frameworks

Attestation Standards

•Statements on Standards for Attestation Engagements (SSAEs) from the Auditing Standards Board (ASB) of the AICPA •Similar to fundamental auditing principles -Practitioner's knowledge about subject matter -Suitable criteria -Evaluation of internal control not required -Restricted distribution

Procedures Following Audit Report Release Date

•Subsequently discovered facts •Omitted procedures •Communication with those charged with governance •Management letters

Internal Audit Standards

•The IIA standards are classified in three major categories: (1) Attribute Standards; (2) Performance Standards; and (3) Implementation Standards. • •The principles of the IIA Code of Ethics are classified in three major categories: •Integrity •establishes trust that is the basis for reliance on auditor's judgment •Objectivity- highest level of professional objectivity in: •gathering, evaluating, and communicating information •balanced assessment of all the relevant circumstances •not unduly influenced by self interests or by others •Confidentiality •respect the value and ownership of information •Competency •apply the knowledge, skills, and experience needed in the performance of internal auditing services

Philosophical Principles in Ethics

•The Imperative Principle •The Principle of Utilitarianism -Act-utilitarianism -Rule-utilitarianism •The Generalization Argument •Virtue Ethics

Service Organizations (AT 801)

•Third-parties often process transactions for other entities. Many companies use third-parties to -process payroll. -handle dividend distribution. -handle investments (banks, brokerage houses). •The controls exist at the third-party provider -The auditors for the users of these services must ensure that those controls at the service provider are adequate. -Providers engage auditors to issue a special report concerning the controls. •Types of Reports -Type 1—Description of controls placed in operation -Type 2—Operating effectiveness (required for Sarbanes-Oxley Act and PCAOB standards) •Included with Service Organization Reports (SOCs)

Fraud Examiner Responsibilities

•To a fraud examiner fraud is always material -It grows -Indicates control weaknesses -Indicates a lack of integrity by the perpetrator •The objective is to uncover fraud when individuals bring forth evidence that indicates that a fraud might exist. -Is fraud present? -What is the scope of the fraud? -Who are the perpetrators? -What control weakness allowed this to occur?

Control Considerations

•Transactions authorized by Board of Directors •Documentation: -Investments in securities •Broker advice for all transactions -Property, plant, and equipment •Vendor's invoice for purchased PPE •Internal cost records for company-built PPE -Bonds and notes payable •Documentation from debtholders -Stockholders' Equity: •Documentation from registrar •Show me the money!! -trace transactions to cash receipts and disbursements journals

Classical Variables Sampling

•Uses normal distribution theory and the central limit theorem to provide an estimated range of -Recorded account balance or class of transactions -Misstatement in an account balance or class of transactions •Basic methodology -Determine estimated range of account balance or misstatement -Evaluate using tolerable misstatement

Trouble Spots in Audits of Investments and Intangibles

•Valuation of investments at cost or market or impairment that is other than temporary •Determination of significant influence relationship for equity method investments •Impairment of goodwill •Capitalization and continuing valuation of intangibles and deferred charges •Propriety, effectiveness, and risk disclosure of derivative securities used as hedges of exposure to changes in fair value (fair value hedge), variability in cash flows (cash flow hedge), or fluctuations in foreign currency •Determination of the fair value of derivatives and securities, including valuation models and the reasonableness of key assumptions •Realistic distinctions of research, feasibility, and production milestones for capitalization of software development costs •Adequate disclosure of restrictions, pledges, or liens related to investment assets

Stockholders' Equity: Substantive Procedures

•With the exception of stock-based compensation plans, audits of stockholders' equity are considered to be low risk •Stockholders' equity transactions usually are well documented in minutes of the meetings of the board directors, proxy statements, and securities offering registration statements -Large corporations' recordkeeping of stock ownership usually are done by a registrar, while small and closely held corporations may have a stock certificate book •Review certificate book for stock issued during the year •Review record of outstanding stock certificates for stock purchased or retired -Transactions must be consistent with the client's articles of incorporation and authorized by the board of directors or its equivalent