Midterm 2 - ACC 358C (Ch. 4-6, 15)
another name for audit documentation
working papers or workpapers
PCAOB rules that audit firm must give ____ ______ to audit committees of all ____________ between (1) the firm and its affiliates and (2) the company and persons with a FROR at the company that may reasonably bear on the firm's __________.
written notice, relationships, independence
Audit-related litigation cost is the ______ largest cost for audit firms.
#2
What are two reasons that a formal qualification to the audit opinion is rare?
(1) companies know that they cannot submit financials that do not follow GAAP (2) problems are usually addressed by auditors before meeting the public's eyes
Why do the issues above create an independence issue?
(1) deepened relationship between the audit firm and executives (2) audit firm may take a position adverse to the audited company is supporting FROR in compensation agreement
Why are AICPA rules more lenient for non-audit services?
(1) fewer people affected by issues in financials for a privately held company (2) more limited resources to seek help with accounting (see auditor as a one-stop-shop)
examples of auditing estimates
- allowance for doubtful receivables - net realizable value for inventory - useful lives of depreciable assets - obligations for warranties and returns - closing and restructuring charges - environmental liabilities - contingencies
What considerations does the auditor have in relying on such evidence?
- credentials of specialist - methodology - data - assumptions
Why is audit evidence considered the core of the audit?
- drives the cost of the audit - takes the most time to gather
What tasks can be completed early?
- internal control assessment and testing - substantive tests of low risk accounts and less activity - cut-off period and testing
What are the drivers of litigation against auditors?
- joint and several liability - class action suits - contingent fees for lawyers - fundamental misunderstanding of what an audit opinion represents
Types of audit procedures
- observation - physical inspection - inquiries and interviews - confirmations - inspection of supporting documents - recalculations - tracing and vouching - analytical procedures and reviews
Three Factors to Consider for Auditing Estimates
- reasonableness of assumptions - consistency with industry standards - consistency with actual experience over time
Independence Rules that Apply to Public and Private Companies: No interest _____________ of total equity of an audited company for _______ _______ of the audit firm.
<5%, any employee
Reliability: _______ ______ is preferable to unsupported verbal evidence.
Documentary evidence
___________ reliance on written rules is imprudent and dangerous.
Exclusive
vouching
F/S --> inception of transaction
(T/F) The auditor is required to audit each quarterly release.
False!
(T/F) The audit program must be static throughout the entirety of the audit.
False! It can be dynamic and change.
(T/F) An auditor could express a qualified opinion on the financial statements, but still issue an unqualified opinion on internal controls.
False! would have to issue adverse opinion on internal controls
Do PCAOB standards converge with those of the AICPA and IAASB?
No.
Paper v. Electronic Documentation: Is one always more reliable than the other?
Not always. Even paper can be intercepted and forged.
Would it make sense to request confirmations from customers who have zero balances on the A/R ledger?
Not really. How can 0 be overstated?
What differentiates physical inspection and observation?
Observation is watching something happen. Physical inspection is looking at a particular asset.
Reliability: _______ _______ are preferable to copies, facsimiles, or digitized data.
Original documents
(T/F) Evidence may be relevant to one assertion, but not another.
True.
What is a limit of observation?
When people know they are being observed, they might be on their best behavior.
Would it make sense to test vendor accounts with zero balances on the A/P ledger?
Yes, because we may be concerned that this liability is understated.
(T/F) The auditor might hire a specialist.
Yes.
direct financial interest
a financial interest owned directly by, or under the control of, an individual or entity or beneficially owned through an investment vehicle, estate, or trust when the beneficiary controls the intermediary or has the authority to supervise or participate in the intermediary's investment decisions
Phase 1: Making client _______ and ______ decisions
acceptance, continuance
commission example
accounting firm has relationship with software vendor and gets cut of the sale when client purchases (based on occurrence of sale)
What are the related accounts in the "acquisitions and payments for inventory, goods, and services" cycle?
accounts payable, inventory, expenses, other assets, cash
Auditor representations _____ _____ _______ do not substitute for explicit audit documentation.
after the fact
For comparative financial statements, the audit opinion covers ______ ______ _______.
all years presented.
What happens if auditor is independent in appearance, but not in fact?
altered audit
Substantive procedures include: substantive ________ procedures & tests of details of _________ _________
analytical, account balances
indirect evidence example
analytics used in risk assessment and in substantive evidence
The main auditor usually does not want to take responsibility for _________ _________ __________.
another firm's audit
Financial Statement Assertions: Valuation or Allocation - inclusion of accounts in financial statements at ___________ ___________
appropriate amounts
What provides the framework for the audit program?
assertions with respect to the accounts and disclosures
What is more likely to be overstated?
assets and revenues
Financial Statement Assertions: Rights and Obligations - ___________ being the rights of an organization - ___________ being the obligations of an organization
assets, liabilities
When does auditor test controls for the opinion on internal control effectiveness?
at year end
Why do the issues above create an independence issue?
audit firm will advocate/support client if going into litigation
example of audit documentation
audit programs summarizing procedure performed by auditor
Phase 1: obtain ___________ _________ on management to assess management integrity
background checks
Phase 1: assess the _________ and _______ of the potential client's accounting personnel
background, experience
Efficient completion of the audit and efficient utilization of audit personnel require much of the audit work to be completed _____ _____ _____.
before year end
What are some services that are prohibited for public audit clients?
bookkeeping/accounting processing, IS design or implementation, valuation, actuarial, internal audit outsourcing, management outsourcing, IB, legal services
Accounting cycles provide for a convenient way to ...
break the audit up into manageable sections of related accounts
examples of sources of risk of material misstatement
business risk, management motivation, process affecting material account balances
How are PCAOB standards organized?
by topical areas that follow the flow of the audit opinion formulation process
Why is having audit documentation on issues important?
can be used in court
Estimates are soft, but a $1 error in an estimate affects net income just as much as a $1 error in _______ ______.
cash sales (something objective)
Ethical Challenges in Auditing: Additional audit effort usually does not ________ _____ ________.
change the outcome
Financial Statement Assertions: Presentation and Disclosure - components of financial statements being properly ___________, __________, and ___________
classified, described, and disclosed
Who might hire the specialist and why?
client b/c the audit firm cannot help them with a difficult accounting task (like valuation of an asset)
No ___________ or __________ solicitation of new audit business.
coercive, misleading
Unqualified Report with Modifications: expresses the auditor's _______ with the fair presentation of the financial statements, but nevertheless calls attention to an __________ __________ that could affect users' ____________ of the financial statements
comfort, important matter, interpretation
No ______________ or __________ ______ for directing business to an audit client or third parties, except for _________ _____where disclosed to the client.
commissions, referral fees, referral fees
Independence does not only mean __________ ________ ________ _______.
compliance with existing rules
Going concern doubt cannot be expressed using __________ wording.
conditional
Other than as prescribed under AICPA/PCAOB standards, an auditor may not communicate __________ _________ _______ concerning audited companies to outside parties.
confidential business information
direct evidence example
confirmation response
What is the most reliable indicator of auditing estimates?
consistency with *actual experience over time*
Why is it okay to do internal control testing early?
controls are not likely to change
Audit evidence is the _______ of the audit.
core
Independence is the _______________ of auditing.
cornerstone
Reasons for Modifications: 6. client _________ of a material misstatement in previously issued financails
correction
Can you date an employee of an audit client?
depends on the firm's rules, more acceptable when you are a junior and so is the person you are dating
What does directional testing mean?
different accounts present different risks of overstatement v. understatement
Reliability: Evidence from ______ ________ is preferable to that indirectly observed.
direct observation
Independence Rules that Apply to Public and Private Companies: no _______________ or _________ ________ financial interest in an audited company by _______ _______
direct, material indirect, covered members
direct evidence
directly proves something without inference necessary
Documentation should cover significant issues or audit findings, such as ___________.
disagreements
What does the Parmalat anecdote teach us?
do not use the client mailroom to send confirmations!
What does sufficiency mean?
do we have enough?
external evidence
document prepared by a third party
internal evidence
document prepared by the audit client
What does it mean for the violation of GAAP to not be pervasive?
does not make the entirety of financial statements misleading by affecting many accounts materially
low control risk: - ___________ internal controls - auditor will test _______ _______ of controls to reduce substantive procedures for account balances
effective, operating effectiveness
Paper v. Electronic Documentation: Which is easier to manipulate?
electronic documentation
covered members: (1) members of the _________ _______ (2) fellow partners of the ___________ __________ __________, resident in the same office (3) people in the firm who have influence on the ________________/____________ of the engagement team
engagement team, lead engagement partner, employment/compensation
example of motivated reasoning & both sides
evaluating going concern issues - report: anger client, tells everyone about issue - relent: company may fail, firm becomes target in litigation
Audit documentation provides _______ that the audit was planned and performed in accordance with auditing standards.
evidence
indirect evidence
evidence that requires a linkage of inferences to provide assurance about the assertion being tested
Financial Statement Assertions: Existence/Occurence - ____________ of assets and liabilities - occurence of recorded ______________
existence, transactions
A confirmation sent to the customer of a client may be relevant to the ________ assertion but not the _________/________ assertion.
existence, valuation/collectibility
Continuance decisions are relevant for _______ clients.
existing
Documentation must be (explict/implicit).
explicit
In general (internal/external) sources provide stronger evidence, particularly if received directly from a ______ _______.
external, third party
Auditor must be independent both in _______ and ________.
fact and appearance
What is usually the claim against the audit firm in a lawsuit?
failure to deliver a quality audit
A qualified opinion asserts that financial statements are presented _____, ______ for XYZ.
fairly, except
Phase 1: analyze client and industry _____ ______ to assess the possibility of business failure
financial statements
A firm is not independent with respect to an audit client if tax advice is (1) proposed by the _____ with (2) a primary goal to ________ ________, and (3) does not meet the ________________________________ standard OR relates to certain types of ________ _________.
firm, avoid taxes, "more likely than not to be upheld", tax shelters
Auditors need to focus on the ______ of transactions in a cycle and the specific _____ and ____ within each cycle.
flow, risks, controls
What is the core of the audit?
gathering and evaluating audit evidence
Reasons for Modifications: 3. _______ ________ doubt
going concern
Usually a client is okay with modifications, unless there is a ...
going concern issue
Quarterly reviews are (greater/lesser) in scope than the CPA's normal "review" services.
greater
What does understanding the risk and controls within each cycle do?
helps determine which specific audit procedures to be used and evidence to be obtained
When are adverse opinions given?
if a material GAAP violation or inadequate disclosure if pervasive enough
How is auditing a company NOT like studying for an exam?
if you study harder, you will most likely earn a better grade; but if you audit more diligently, you will most likely come to the same conclusion as if you cut corners
Independence Rules that Apply to Public and Private Companies: Covered members cannot have ____________ __________ members who hold ________ ________ in the audited company.
immediate family, key positions (FROR)
What is the difference between being independent in fact and appearance?
in fact: truly unbiased in reality in appearance: "appearing" to be independent to some 3rd party
Reasons for Qualified Opinion: 2. __________ disclosure
inadequate
tracing
inception of transaction --> F/S
substantive audit
includes substantive procedures and *does not* include tests of controls
controls reliance audit
includes test of controls and substantive procedures
Phase 1: inquire of the client firm personnel whether there are any potential ____________ relationships
independence-impairing
Reasons for a Disclaimer: 1. auditor is not ________
independent
Reliability: Evidence from _____ ______ ________ is better than coming from the client.
independent outside sources
Risk Assessment Procedures: - ___________ of management and others within the entity - planning ___________ procedures - __________ and inspection of documentation
inquiries, analytical, observation
Phase 3: Obtaining evidence about ________ _________ operating effectiveness
internal control
Phase 1: review regulatory filings and inquire of management about any _________ ________ _______
internal control deficiencies
What is the weakest type of evidence?
internal evidence given to you by the client itself
Where does the most evidence come from?
internal evidence given to you by the client itself
IAASB standards are used by which companies?
international
If circumstances change such that the Year 1 opinion is no longer appropriate in Year 2, what should the auditor do?
issue the report that is currently appropriate, disclosing and explaining the change
Going through the motions of collecting audit evidence is of little help if one does not constantly exert _________, ______ _____, and _______ _________.
judgment, common sense, skepticism
Reasons for Modifications: 1. ______________ departure from GAAP
justified
What is a common criticism by the PCAOB in their inspection reports?
lack of sufficient, appropriate audit evidence
What is an audit scope limitation?
lack of sufficient, appropriate audit evidence or restrictions on the scope of the audit
statutory law
law developed through legislation, such as the Securities Act of 1933 or Securities Exchange Act of 1934
class action lawsuits
lawsuits that are brought on behalf of a large group of plaintiffs to consolidate suits and to encourage consistent judgements and minimize litigation costs
AICPA rules on non-audit services are more ___________ for audits of ______ _______ companies and other entities that are not __________ ________.
lenient, privately held, publicly traded
What is more likely to be understated?
liabilities and expenses
common law
liability concepts are developed through court decisions based on negligence, gross negligence, or fraud
contract law
liability occurs where there is a breach of contract
Ethical Challenges in Auditing: Human nature is to be friendly, flexible, and helpful. We ________ ______ ______ _______. However, effective auditing requires maintaining ________ ________, _________, and sometimes __________.
like to be liked, consistent standards, skepticism, confrontation
Is tracing or vouching appropriate for A/R? Would it likely be under or overstated?
likely overstated --> vouching
Is tracing or vouching appropriate for A/P? Would it likely be under or overstated?
likely understated --> tracing
The most important ethical responsibility of the auditor is to ....
maintain independence from the company being audited
Phase 2: auditor establishes a __________ level overall and for specific accounts and disclosures
materiality
critical audit matters (CAMs)
matters required to be communicated to the audit committee, relating to FS or disclosures, and involving "especially challenging, subjective, or complex auditor judgement"
expectations gap
misunderstanding whereby shareholders mistakenly believe that they are entitled to recover losses on investments for which the auditor provided an unqualified opinion on the financial statements
Ethical Challenges in Auditing: _____ ________ can lead auditors to rationalize problems away.
motivated reasoning
Acceptance decisions are relevant for _______ clients.
new
Section 201 of SOX prohibits most _____________ ________ for public audit clients.
non-audit services
A disclaimer is essentially a ______.
non-opinion
Going concern doubts assess whether a firm can continue operating ________ in the next year.
normally
An adverse opinion asserts that financial statements are ______ presented fairly, due to XYZ.
not
Does an auditor need to explain why they lack independence?
not necessarily
What the the convention used by the PCAOB?
numbering (AS 1, ...)
The audit program specifies _______ for the audit and the _______ and _____ used to gather and evaluate audit evidence.
objectives, tests, procedures
Whether or not a CPA is conducting audits, they must adhere to the following rule: in the performance of any professional service, a CPA shall maintain ___________ and ________.
objectivity, integrity
Even ______ person on the team can blow the __________ independence.
one, firm's
Documentation can be in which two forms?
paper or computerized
Reasons for Modifications: 5. information about audit __________ / reference to _______ auditors
participants, other
Ethical Challenges in Auditing: It is difficult to stand against the party that is ________ _______ ________. This is why the enhanced role of the _________ audit committee is critical.
paying your fee, independent
contingent fee
payment depends on some future event occurring or not
Firm can survive litigation, but they can't survive ...
perceived lack of integrity and independence
A firm is not independent with respect to a public audit client if it provides ________ __________ __________ to any person who is in a _________ __________ ________ role at the company.
personal tax advice, financial reporting oversight
Reasons for Qualified Opinion: 1. material, but not _______, _______ violation of GAAP
pervasive, justified
What does documentation cover?
planning, risk assessment, and audit work performed
What is someone in a financial reporting oversight role?
prepares the financial statements or influences the financial statements
Reasons for Modifications: 2. change in accounting ____________
principle
AICPA standards are used by which companies?
private
KAMs are for (public/private) company audits.
private
True reviews can only occur for which types of companies?
private
What is the common objective among all auditing standards?
provide assurance to public that audits are conducted in a quality manner
CAMs are for (public/private) company audits.
public
PCAOB standards are used by which companies?
public
Contingent fee arrangements with an audit client (_________ or ________) are _______ _________. This includes any contingent fees for ____ ______ provided to an audit client.
public, private, not permitted, tax services
Phase 1: perform a review of any ___________ _________ __________ that might indicate management's lack of commitment to GAAP
questionable accounting policies
The change must be _____ and _____ to justify and explanatory paragraph.
reasonable, appropriate
accounting cycles
recording and processing transactions that affect a group of related accounts
What happens if auditor is independent in fact, but not in appearance?
reduced credence of audit
referral fee example
referring a client to a lawyer and getting a fee for the referral alone
What does the term substantive mean?
relating to financial statement testing
What does appropriate audit evidence mean/entail?
relevant to the assertion and reliable (strong)
Phase 5: Completing the audit and making ________ ________
reporting decisions
example of when audit opinion would be revised
resolution of going concern issue
What is the most critical part of risk assessment?
responding to identified risks of material misstatement
What does the auditor do quarterly?
review quarterly releases
Phase 5: - completing various ________ and ______ activities - making a decision about what types of _______ should be issued
review, communication, opinions
Phase 2: Performing _______ ________
risk assessment
What are the three audit procedures?
risk assessment procedures, tests of controls, substantive procedures
control risk
risk that a particular control will not detect a material misstatement in a timely manner
What is a tax shelter?
scheme or arrangement to avoid taxes
Reasons for Qualified Opinion: 3. audit _________ limitations
scope
Reasons for a Disclaimer: 3. severe ________ limitation
scope
What is NOT a reason that an adverse opinion can be given?
scope limitations
The review process for interim statements of a public company is taken _____________ and has the feel of a ______ ______ _____.
seriously, year end audit
Phase 2: requires identification of ___________ accounts, disclosures, and relevant assertions
significant
Considerations in determining appropriate substantive procedures: _________, ____, and ________of potential misstatement
source, extent, type
However, auditors must provide audit-related information if it is ____________ in _________ ______.
subpoenaed, legal proceedings
Reasons for a Disclaimer: 2. ___________ doubt about the client's ability to continue as a _______ _______, and mere modification is not sufficient
substantial, going concern
Phase 4: Obtaining ___________ evidence about accounts, disclosures, and _______
substantive, assertions
What is the defining characteristics that allows a valid opinion to be issued?
sufficient, appropriate audit evidence
What is the most important document in the audit?
the audir program
Who has the ultimate responsibility for providing a quality audit?
the audit firm
A justified departure from GAAP must be one that ...
the audit firm agrees with
Why is inadequate disclosure rare?
the audit opinion would call attention to the amtter anyway
The audit committee is the buffer between ....
the auditor and company's management
Who has the ultimate responsibility for the financials?
the company (client)
What two things does the auditor need to be comfortable with when evaluating estimates?
the methods used and the data
inherent risk
the risk that something either is not recorded or that it is recorded in error (before consideration of controls)
When does auditor test controls for the financial statement audit?
throughout the year
Financial Statement Assertions: Completeness - inclusion of all ___________ and __________ in the financial statements
transactions, accounts
joint and several liability (deep-pocket theory)
type of liability that apportions losses among all defendants who have an ability to pay for the damages, regardless of the level of fault
Reasons for Modifications: 4. other ________ or significant matters that warrant emphasis, such as =: - significant contingencies or risks - significant subsequent events - significant related-party transactions
uncertainties
An auditor could express an adverse opinion on internal controls, but still issue an ___________ opinion on the financial statements.
unqualified
What is the most common opinion?
unqualified (clean)
What is the order of opinions, from most to least desirable for a client?
unqualified, unqualified with modifications, qualified, adverse, disclaimer
Independence Rules that Apply to Public and Private Companies: No _________/_________ _________ between audit clients and covered members. Normal loans on standard terms _____________.
unusual, investment loans, permitted
What you write can and will be _____ _____ ______, so be careful!
used against you
What would give you more comfort about information available only in electronic form?
using secured means and safeguards to check on senders
How is evidence gathered?
via audit tests and procedures
Changes in accounting principles can be ____________ or __________ by a change in GAAP.
voluntary, forced
high control risk: - ___________ internal controls - auditor cannot rely on controls to ________ substantive procedures for account balances
weak, reduce
Reliability: A _______ _________ _____ that is difficult to override provides more reliable evidence.
well-controlled information system
When are tax services for an audit firm allowed?
when approved by the board/audit committee
When does a disclaimer result?
when auditor lacks sufficient evidential basis for expressing an independent audit opinion
When is it okay to do substantive tests of low risk accounts?
when rigorous roll-forward procedures are used
indirect financial interest
when the beneficiary neither controls the intermediary nor has the authority to supervise or participate in the intermediary's investment decisions (ex: mutual fund)
What distinguishes internal and external evidence?
who prepared the documentation
The audit program will indicate _____ performed procedures and ______.
who, when