Audit Midterm 1

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auditing has no effect on on either the risk-free interest rate or business risk but it has a significant effect on

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information risk

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causes of information risk (4)

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*remoteness of information
*biases and motives of the provider
*voluminous data
*complex exchange transactions

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ways to reduce information risk (3)

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*user verifies information
*user shares information risk with management
*audited financial statements are provided

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remoteness of information

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when information is obtained from others the likelihood of it being intentionally or unintentionally misstated increases

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biases and motives of the provider

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if information is provided by someone whose goals are inconsistent with those of the decision maker the information may be biased by the provider

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voluminous data

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as organizations become larger, so does the volume of exchange transactions-this increases the likelihood that improperly recorded information is included in the records

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complex exchange transactions

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exchange transactions have become increasingly complex, for example properly disclosing derivatives

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PCAOB

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appointed and overseen by the SEC provides oversight for auditors of public companies, establishes auditing and quality control standards for public company audits, and performs inspections of the quality controls at audit firms performing those audits

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PCAOB

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requires annual inspections of accounting firms that audit more than 100 issuers and inspections of other registered firms at least once every three years

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SEC

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assists in providing investors with reliable information upon which to make investment decisions

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Securities Act 1933

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any company planning to issue new securities to the public must submit registration with the SEC for approval

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Securities Exchange Act 1934

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requires public companies to file detailed annual reports with the commission

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10 K

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annually with 60 to 90 days after close of fiscal year

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AICPA

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membership is restricted to CPA's but not all members are auditors

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AICPA sets standards and rules that all members and other practicing CPA's must follow: (4) major areas are as follows:

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*auditing standards
*compilation and review standards
*other attestation standards
*code of professional conduct

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Auditing Standards Board

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responsible for issuing pronouncements on auditing matters for all entities other than publicly traded companies

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ASB pronouncement called

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Statements on Auditing Standards

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Accounting and Review Services committee

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responsible for issuing pronouncements of the CPA's responsibility when associated with financial statements of privately owned companies that aren't audited

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SSARS (statements on Standards for Accounting and Review services)

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ARS committee

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AICPA committee on Professional Ethics

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sets rules of conduct that CPA's are required to meet.

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AICPA publishes

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*Journal of Accountancy
*Codification of Statements on auditing standards
*Code of professional conduct

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AICPA

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writes and grades the CPA exam

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ASB

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audit standards private companies

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PCAOB

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audit standards public companies

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GAAS

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generally accepted auditing standards

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GAAS

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established by the ASB of the AICPA for PRIVATE companies

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GAAS (3 categories)

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1. General Standards
2. Standards of Field work
3. Standards of Reporting

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general standards (TIP)

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1. the auditor must have adequate TECHNICAL TRAINING and proficiency to perform the audit
2. The auditor must maintain INDEPENDENCE in mental attitude in all matters relating to the audit
3. The auditor must exercise due PROFESSIONAL care in the performance of the audit and the preparation of the report
3.

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Standards of Field Work (PIE)

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1. the auditor must PLAN the work and must properly supervise any assistants
2. The auditor must obtain a sufficient understanding of the entity and its environment including its INTERNAL CONTROLS, to assess risk of material misstatement of the financial statements whether due to error or fraud-and nature timing and extent of further audit procedures
3. The auditor must obtain sufficient appropriate audit EVIDENCE by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.
3.

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Reporting Standards (CGOD)

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1. the auditor must report CIRCUMSTANCES in which principles have not been observed
2. The auditor must state in the report that the financial statements are presented in accordance with GAAP
3. The auditor must express and OPINION regarding the financial statements, taken as a whole, or state that an opinion cannot be expressed, in the auditors report.
4. When the auditor determines that informative DISCLOSURES are not adequate they must state so in the report

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general standards

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personal qualities auditors should possess

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standards of field work

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concern evidence accumulation and other activities during the audit

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standards of reporting

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auditor must prepare a report on the financials taken as a whole including disclosures

the report must state if presented in accordance with GAAP

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GAAS

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authoritative

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standard unqualified report (7) parts

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1. report title
2. audit report address
3. intro paragraph
4. scope paragraph
5. opinion paragraph
6. name of CPA firm
7. Audit report date

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report title

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must contain the word INDEPENDENT

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audit report address

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addressed to company, stock holders, or board of directors

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Introductory paragraph (3 things)

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1. it states the CPA has performed an audit
2. lists the financial statements that were audited including the balance sheet dates and the accounting periods for the income statement and statement of cash flows
3. states that the statements are the responsibility of management and that auditors responsibility to express an opinion on those statements based on the audit

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scope paragraph

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factual statement about what the auditor did in the audit, followed US GAAP, if public followed PCAOB
-states that the audit is designed to obtain reasonable assurance whether the financials are free from material misstatement

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opinion paragraph

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auditors conclusion based on the result of the audit "present fairly"

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audit report date

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the date the auditor completed work in the field

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standards unqualified report is issued under the following (5) conditions:

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1. all statements :BS, IS, Statement of RE, statement of cash flows are included in the financial statements
2. three general standards have been followed in all respects
3. sufficient evidence has been accumulated-three standards of field work have been met
4. financials are presented in accordance with GAAP
5. No circumstances requiring addition of explanatory paragraph or modification of the wording of the report

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standard unqualified report

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clean opinion

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unqualified with explanatory paragraph or modified wording

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a complete audit took place with satisfactory results and financial statements are fairly presented, but the auditor believes that it is important or is required to provide additional info

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qualified

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the auditor concludes that the overall financial statements are fairly presented, but the scope of the audit has been materially restricted or GAAP was not followed in preparing financial statements

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adverse or disclaimer

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the auditor concludes that the financial statements are not fairly presented (adverse), he or she is unable to form an opinion as to whether the financial statements are fairly presenter (disclaimer), not independent (disclaimer)

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addition of explanatory paragraph (if material)

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*lack of consistent application of GAAP
*substantial doubt about going concern
*auditor agrees with departure from principles
*emphasis of a matter

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modified wording (if material)

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reports including other auditors

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scope restricted by client or other conditions (material but doesn't overshadow)

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qualified scope, additional paragraph, and qualified opinion "except for"

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scope restricted by client or other conditions (so material fairness is questioned)

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disclaimer

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financial statements not prepared according to GAAP (material but doesn't overshadow financial statements as a whole)

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additional paragraph and qualified opinion "except for"

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financial statements not prepared according to (so material that overall fairness if questioned)

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adverse-really bad

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auditor not independent regardless of materiality

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disclaimer

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the responsibility for adopting sound accounting policies, maintaining adequate internal control, and making fair representations in the financial statements rest with

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management

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management is responsible for

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internal controls and the financial statements

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SOX requires

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CEO, CFO of public companies to certify the quarterly, and annual financial statements submitted to the SEC

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SOX provides:

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criminal penalties for anyone who knowingly falsifies financial statements

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auditor is responsible for

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detecting material misstatements from error or fraud

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if auditor reports on the effectiveness of internal control of financial statements

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the auditor is responsible for identifying material weaknesses in the internal controls

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audits are performed by dividing the financials statements into

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smaller segments or components

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cycle approach

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a method of dividing an audit by keeping closely related types of transactions and account balances in the same segment

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sales and collection cycle

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-sales
-sales returns
-cash receipts
-charge offs
(all affect accounts receivable)

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cycles (5)

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-sales and collection
-acquisition and payment
-payroll and personnel
-inventory and warehousing
-capital acquisition and repayment

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sales and collection accounts

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-cash
-A/R
-allowance for accounts
-bad debt expense
-sales
-sales returns and allowances

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payroll and personnel accounts

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--cash
-accrued payroll
-accrued payroll taxes
-salaries and commissions
-sales payroll taxes
-admin payroll taxes
-exec and office salaries

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inventory and warehousing accounts

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-COGS
-inventory

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capital acquisition and repayment (financing activities)

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-cash
-notes payable
-LT notes payable
-accrued interest
-capital stock
-capital stock in excess of par
-RE
-dividends
-dividends payable
-interest expense

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acquisition and payment (operating)

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-operating expenses
-cash
-inventories
-land
-buildings
-prepaids
-computers
-furniture
-A/P
-deferred taxes
-accrued taxes
-accumulated depreciation

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cycle approach promotes

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efficiency and effectiveness

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cycle approach helps to focus on important account balances surrounding a transaction in (3) ways:

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1. facilitates gathering sufficient audit evidence
2. can provide corroborating evidence about accounts in other cycles
3. views the accounting process as a system

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management assertions about TRANSACTIONS (5)

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*occurrence
*completeness
*accuracy
*classification
*cutoff

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Mgt. trans assertion: OCCURRENCE

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did the transaction occur? We are concerned with OVERstatement

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Mgt. trans.assertion COMPLETENESS

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did we record all transactions? we are concerned with understatment

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Mgt. trans. assertion: ACCURACY

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have the transactions been recorded at the correct amounts?

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Mgt. trans. assertion: CLASSIFICATION

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are the transactions recorded in the appropriate account?

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Mgt. trans. assertion: CUTOFF

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are the transactions recorded in the appropriate period

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Mgt. Assertions about account BALANCES (4)

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*existence
*completeness
*valuation and allocation
*rights and obligations

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Mgt. ass. balance: EXISTENCE

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did assets, liabilities, and equity interests included in the BS actually exist on the BS date?

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Mgt. ass. blance: COMPLETENESS

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are all accounts and amounts that should be in the statements included?

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Mgt. ass. balance: VALUATION & ALLOCATION:

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deal with whether assets, liabilities and equity interests have been included in the financial statements at appropriate amounts-including valuation adjustments to reflect asset net realizable vale

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Mgt. ass. blance: RIGHTS & OBLIGATIONS

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whether assets are the rights of the entity and whether liabilities are obligations at a given date

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Mgt. assertions about PRESENTATION & DISCLOSURE (4)

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-Occurrence and Rights & obligations
-completeness
-accuracy and valuation
-classification and understandability

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Mgt. ass. disclosure: OCCURRENCE and RIGHTS & OBLIGATIONS

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did disclosed events occur and are they the rights and obligations of the entity?

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Mgt. ass. disclosure: COMPLETENESS

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have all disclosures been included

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mgt. ass. disclosure: ACCURACY & VALUATION

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has financial info been disclosed fairly and at appropriate amounts?

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Mgt. ass. disclosure: CLASSIFICATION & UNDERSTANDABILITY

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are the amounts appropriately classified in the financial statements and footnotes and are the balance descriptions and related disclosures understandable?

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Audit objectives (3)

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1. transactions
2. balances
3. presentation and disclosure

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Transaction related audit objectives (6)

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1. occurrence
2. completeness
3. accuracy
4. posting and summarization
5. classification
6. timing

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Trans. Aud. obj: OCCURRENCE:

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events and transactions have actually occurred-recorded transactions exist

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Trans. Aud. Obj: COMPLETENESS:

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transactions that should have been recorded are-existing transactions are recorded

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Trans. Aud. obj.: ACCURACY

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recorded transactions are stated at correct amounts

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Trans. Aud. Obj.: POSTING & SUMMARIZATION

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transactions are included in the master files and are correctly summarized

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Trans. Aud. Obj.: CLASSIFICATION

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transactions are properly classified

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Trans. Aud. Obj.: TIMING

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transactions are recorded on the correct date.

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management assertion ACCURACY

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audit object:
accuracy
posting and summarization

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management assertion CUTOFF

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audit objective:
timing

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Bal. related Aud. Objectives (8):

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1. existence
2. completeness
3. accurracy
4. classification
5. cut-off
6. detail tie in
7. realizable value
8. rights and obligations

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bal. related aud. obj: CUTOFF

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transactions near the balance sheet date are recorded in the proper period

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bal. related aud. obj: DETAIL TIE-IN:

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details in the account balance agree w/ related master file amounts, foot to the total in the account balance and agree with the total in the GL

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mgt. assertion balance: VALUATION & ALLOCATION

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balance related aud. obj:
-accuracy
-classification
-cutoff
-detail tie in
-realizable value

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disclosure related audit objectives (4)

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-occurrence and Rights & obligations
-Completeness
-valuation and allocation
-classification and understandability

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Rule 101-Independence

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A member in public practice shall be independent in the performance of professional service as required by standards promulgated by bodies designed by council

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Interpretation of Rule 101 prohibits covered members from owning ANY stock or OTHER DIRECT INVESTMENT in audit clients because it is potentially damaging to actual audit independence

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Covered members include:
*members of the attest team
*individuals who supervise or evaluate the audit partner (significant influence)
*a partner or manager who provided nonattest services to the client
*a partner in the office of office of the partner responsible for the attest engagement
*the firm and it's employee benefit plan
*an entity that can be controlled by any covered members listed above or by two or more of the covered individuals or entities operating together

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independence is NOT impaired if

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the covered member is not aware of a close relatives ownership interest in a client

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client investor

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if clients investment in the nonclient is material, any direct or indirect investment by the CPA in the nonclient investee impairs independence

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client investee

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if investment in a client is material to a nonclient investor, any direct or material indirect investment by the CPA in the nonclient impairs independence

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three important requirements that an auditor must satisfy before it is acceptable to do bookkeeping and auditing for a private client

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1. client must accept full responsibility for financial statements
2. The CPA must not assume the role of employee or of management conducting the operations of an enterprise
3. The CPA, in making an audit of financial statements prepared from books and records that the CPA has maintained completely or in part, must conform to GAAS.

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Rule 102: integrity and objectivity

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in the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others

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free of conflicts of interest

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absence of relationships that might interfere with objectivity or integrity

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Rule 201: General Standards

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1. professional competence
2. due professional care
3. Planning and supervision
4. sufficient relevant data

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Rule 301: confidential client info

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shall not disclose confidential information without the consent of the client

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exceptions to confidentiality:

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1. obligations related to technical standards
2. subpeona or summons and compliance with laws and regulations
3. peer review
4. response to ethics division

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Rule 302: Contingent fees

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DO NOT accept contingent fees for:
-audit or review of financial statement
-compilation for a third party
-prepare a tax return based on a refund

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Rule 501: Acts discreditable

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-retention of client records
-discrimination and harassment in employment practices
-standards on government audits and requirements of government bodies and agencies
-negligence in the preparation of financial statements or records
-failure to follow requirements of governmental bodies, commissions, or other regulatory agencies
-failure to file a tax return, or pay tax liability
-Solicitation or disclosure of CPA examination questions and answer

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code of Professional conduct: an AICPA membership can be terminated w/o a hearing for judgment conviction for any of the following four crimes:

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-imprisonment for more than 1 year
-the willful failure to file any income tax return that the CPA is required to file
-the filing of a false or fraudulent income tax return
-aiding in preparing a fraudulent tax return

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Rule 503-commissions and referral fees

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prohibited commissions:
-for an audit or review
-a compilation of a financial statement when a 3rd party is suspected to use it
-examination of prospective financial info
DISCLOSE permitted commission
DISCLOSE referral fees

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breach of a state board of accountancy code can result in

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loss of CPA certificate and the license to practice

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nonaudit services prohibited due to independence SOX / SEC

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1. bookkeeping and other accounting srvcs
2. financial information systems design and implementation
3. appraisal or valuation srvcs
4. Actuarial srvcs
5. Internal audit outsourcing
6. Management or human resource functions
7. Broker or dealer or investment adviser or investment banker services
8. Legal and expert services unrelated to the audit
9. any other srvc that the PCAOB deems impermissible

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CPA firm is NOT independent if the audit partner receives compensation for services other than

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-audit
-review
-attest services