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62 Cards in this Set

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What is the purpose of an audit according to auditing standards?
The purpose of an audit is to provide financial statement users with an opinion by the auditor on whether the financial statements are presented fairly, in all material respects, in accordance with the applicable financial accounting framework.
What do auditors do and why?
Auditors accumulate evidence in order to reach conclusions about whether the financial statements are fairly stated and to determine the effectiveness of internal control, after which they issue the appropriate audit report.
What does the auditor do if he doesn't believe the statements are presented fairly?
If he believes they are not presented fairly or is unable to reach a conclusion because of insufficient evidence, the auditor has the responsibility of notifying users through the auditor's report.
What happens if subsequent to their issuance of the auditor's report evidence that the statements were not presented fairly surfaces?
The auditor will probably have to demonstrate to the courts or regulatory agencies that the audit was conducted in a proper manner and the auditor reached reasonable conclusions.
5 Steps to Develop Audit Objectives
1. Understand objectives and responsibilities for the audit.
2. Divide financial statements into cycles.
3. Know management assertions about financial statements.
4. Know general audit objectives for classes of transactions, accounts, and disclosures.
5. Know specific audit objectives, for classes of transactons, accounts, and disclosures.
What is management responsible for?
Management has the responsibility for adopting sound accounting policies, maintaining adequate internal control, and making fair representations in the financial statements.
Why is management responsible for adopting sound accounting policies, maintaining adequate internal control, and making fair representations in the financial statements.?
The company's management knows more about the company's transactions and related assets, liabilities, and equity than the auditor.
What does the auditor know of the company's transactions and related assets and liabilities?
The auditor's knowledge of these things is limited to what they acquire during the audit.
What is present in the annual reports of many public companies?
In the annual reports of many public companies there is a statement about management's responsibilities and relationship with the CPA firm.
What is management's responsibility and what does it carry with it?
Management's responsibility for the integrity and fairness of the representations in the financial statements carries with it the privilege of determiniing which presentations and disclosures it considers necessary.
What can the auditor do if they disagree with management?
If management insists on financial statement disclosure the auditor finda unacceptable, the auditor can either issue an adverse opinion or withdraw from the audit.
What requires the CEO and CFO to certify the quarterly and annual statements?
Sarbanes Oxley requires the CEO and CFO to sign the statements.
When the CEO and CFO sign the financial statements what are they certifying?
In signing the statements, management is certifying that the financial statements fully comply with the requirements of the SEC Act of 1934 and that the info contained in the statements fairly presents, in all material respects, the financial condition and results of operation.
What happens if the CEO and CFO sign the statements but the statements are not prepared in accordance with SEC Act of 1934?
SOX provides for criminal penalties, including significant monetary fines or imprisonment up to 20 years, for anyone who knowingly falsely certifies financial statements.
What are the 2 overall objectives of auditors?
1. To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.
2. To report on the financial statements, and communicate as required by auditing standards, in accordance with the auditor's findings.
When the auditor reports on internal control what must they do?
They must identify material weakness in internal control over financial reporting.
When is a misstatement considered material?
A misstatement is usually considered material if the combined uncorrected errors and fraud in the financial statements would likely have changed or influenced the decisions of a reasonable person using the statements.
What type of assurance do auditor's provide and why?
Auditor's are responsible for obtaining reasonable assurance that the materiality threshold has been satisfied. It would be incredibly costly for auditors to be responsible for finding all immaterial errors and fraud.
Assurance
A measure of the level of certainty that the auditor has obtained at the completion of the audit.
What is reasonable assurance according to auditing standards?
According to auditing standards, reasonable assurance is a high, but not absolute, level of assurance that the financial statements are free from material misstatements.
What does the reasonable assurance standard indicate in regards to the auditor?
This indicates that the auditor is not an insurer or guarantor of the correctness of financial statements. So an audito conducted in accordance with auditing standards may still fail to detect a material misstatement.
The auditor is responsible for reasonable, but not absolute assurance for 3 main reasons.
1. Most audit evidence results from testing a sample of a population such as a/r or inventory. Sampling inevitably leads to some risk of not uncovering a material misstatement. Also, areas to be tested, type, extent, and timing of those tests, and evaluation of test results require significant auditor judgement. Even with good faith and integrity, auditors can make mistakes and errors in judgement.
2. Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. AS a result, the auditor has to rely on evidence that is persuasive, but not convincing.
3. Fraudulently prepared financial statements are often extremely difficult, if not impossible, for the auditor to detect, especially when there is collusion among management
Since audit evidence comes from testing a sample population what does this mean for assurance auditors can provide?
Sampling inevitably leads to some risk of not uncovering a material misstatement. Also, areas to be tested, type, extent, and timing of those tests, and evaluation of test results require significant auditor judgement. Even with good faith and integrity, auditors can make mistakes and errors in judgement.
What impact does the presence of accounting estimates have assurance auditors can provide?
Accounting presentations contain complex estimates, which inherently involve uncertainty and can be affected by future events. AS a result, the auditor has to rely on evidence that is persuasive, but not convincing.
How do fraudulent financial statements impact the assurance auditors can provide?
Fraudulently prepared financial statements are often extremely difficult, if not impossible, for the auditor to detect, especially when there is collusion among management
Error
An error is an unintentional misstatement of financials
Fraud
Fraud is intentional misstatement of financials.
What are the 2 distinct types of fraud?
Misappropriation of assets.
Fraudulent financial reporting.
What type of fraud is typically done by employees?
Misappropriation of assets often called defalcation or employee fraud.
What is an example of misappropriation of assets?
A clerk taking cash at he time a sale is made and not entering the sale in the cash register.
What is an example of fraudulent reporting?
Intentional overstatement of sales near the balance sheet date to increase reported earnings.
What is an attitude of professional skepticism?
PRofessional skepticism is an attitude that includes a questioning mind and a critical assessment of audit evidence. Auditors should not assume management is dishonest but the possibility of dishonesty must be considered.
What do auditors spend alot of time doing?
They spend a lot of time planning and performing audits to detect unintentional mistakes made by management and employees. Often they find errors resulting from mistakes in calculations, omissions, misunderstanding and misapplication of accounting standards, and incorrect summarizations and descriptions.
What distinction is made by auditing standards between the auditor's responsibility for detecting fraud and errors
NONE. Auditors must obtain reasonable assurance that the statements are free from both. They do, however, recognize that fraud is more difficult to detect because employees and managemnet work to cover it up
How does fraudulent reporting harm investors?
This provides them incorrect financial statement information for decision making.
Who does misappropriation of assets harm? In what way?
When assets are misappropriated, stockholders, creditors, and others are harmed because assets are no longer available to their rightful owners.
Who typically commits fraudulent financial reporting?
Management sometimes wihtout the knowledge of employees. THey are in a position to make accounting and reporting decisions without employees knowledge. An example is the decision to omit an imortant footnote disclosure about pending litigation.
Illegal acts
Violations of laws or government regulgations other than fraud. Example violation of federal tax laws, violation of federal environmental protection laws.
Direct effect illegal acts.
Certain violations have direct effect on specific account balances in financial statements. Example, violation of federal tax law affects income tax expense and income tax payable.
What responsibility does an auditor have for direct effect illegal acts?
The auditors responsiblity for these is the same as the responsiblity for erors and fraud. Normally evaluates if there is evience to indicate material violations of federal or state tax. To do this they might hold discussions with client personnel, examine reports issued by the IRS after completion of an examination of the tax return.
Indirect-effect illegal Acts
Most affect only indirectly. If the company violates EPA laws, financial statements areaffected only if there is a fine or sanction. Potential material fines and sanctions indirectly affect financial statements by creating the need to disclose a contingent liability for the potential amount that might ultimately be paid. This is called an indirect-effect illegal act.
What type of assurance do auditors provide against illegal-effect acts?
Auditing standards state that the auditor provides NO ASSURANCE that indirect-effect illegal acts will be detected. Auditorslack legal expertise, and the frequent indirect relationship between illegal acts and financial statements makes it impractical for auditors to assume responsibility for discovering illegal acts.
Auditors have 3 levels of responsibility for finding and reporting illegal acts:
1. Evidence accumulation when there is no reason to believe there is an illegal act.
2. Evidence when there is reason to believe
3. Actions when they know there is an illegal act.
Evidence accumulation when there is no reason to believe indirect-effect illegal acts exist.
MAny audit procedures normally performed on audits to search for errors and fraud may also uncover illegal acts. The auditor should also inquire of management about policies they have established to prevent illegal acts and whether management knows of any laws or regulations that the company has violated. Other than these procedures, the auditor should not search for indirect illegal acts unless there is reason to believe they exist.
Evidence accumulation and other actions when there is reason to believe direct or indirect effect illegal acts exist.
1. The auditor should inquire of management at a level above those likely to be involved in the potential illegal act.
2. The auditor should consoult with the client's legal council or other specialist who is knowledgeable about the potential illegal act.
3. The auditor should consider accumulating additional evidence to determine whether there actually is an illegal act.
Actions when the auditor knows of an illegal act.
The first course of action is to consider effect on financial statements including adequacy of disclosure. If the auditor concludes that the disclosures relative to an illegal act are inadequate, the auditor should modify the report accordingly. The auditor should also consider the effect of such illegal acts on the CPA firm's relationship with management. If management knew of the illegal act but failed to inform the auditor, it is questionable whether management can be believed in other discussions.
Why should you question management if they failed to tell you about illegal action?
The auditor should also consider the effect of such illegal acts on the CPA firm's relationship with management. If management knew of the illegal act but failed to inform the auditor, it is questionable whether management can be believed in other discussions.
What should the auditor do in regards to communication when an illegal act is discovered?
The auditor should communicate with the audit committee or others of equivalent authoity to make sure they know of the illegal act. The communication can be oral but if so it should be documented in the audit files. If the client refuses to accept the auditor's modified report or fails to take appropriate remedial action concerning the illegal act, the auditor may find it necessary to withdraw from the engagement If the client is publically held the auditor must report the matter directly to the SEC
How are audits performed?
Audits are performed by dividing the financial statements into smaller segemented componennets
Why are audits separated?
The division makes the audit more manageable and aids in the assignment of tasks to different members of the audit team. Each segment is audited separately but not on a completely independent basis. After the audit of each segment is complete including the interrelationships with other segments, the results are combined. A decision about the financial statements taken as a whole can then be made and an opinion issued.
Cycle approach
A common way to divide an audit is to keep closely related types or classes of actions and account balances in the same segment.
What is the logic behind the cycle approach?
The logic is that it ties to the way transactions are recorded in journals and summarized in the general ledger and financial statements. The cycle approach combines transactions recorded in different journals with the general ledger balances that result from those transactions.
What are the 5 cycles in the cycle approach?
1. Sales and collection cycle
2. Acquisition and payment cycle
3. Payroll and personnel cycle
4. Inventory and warehousing cycle
5. Capital acquisition and repayment cycle.
What function does a trial balance have in an audit
A trial balance is used to prepare financial statements and is a primary focus of every audit. Prior year account balances are usually incuded for comparative purposes.
What is true of all accounts and journals in the cycle approach?
All general ledger accounts and journals are included at least once
What is true of some journals and accounts in the cycle approach?
Some journals and general ledger accounts are included in more than one cycle. When that occurs, it means that the journal is used to record transactions from more than one cycle and indicates a tie in between the cycles. The most important general ledger account included in and affecting several cycles is general cash.
What is the primary focus of most audits in the cycle approach?
The sales collection cycle is the first ccle listed and is a primary focus on most audits. Collections on trade accounts receivable in the cash receipts journal is the primary operating inflow to cash in the bank.
In the cycle approach what can be said about acquisition and payments
CApital acquisition and repayment cycle is closely related to acquisition and repayments. Transactions in acquisitions and payments includes purchase of inventory, supplies, and ohter goods and services relating to operations. Capital acquisition and repayment relate to financiing the business such as issuing stock or debt, paying dividends, and repaying debt
Do the acquisition and payments cycle and capital acquisition and payments schedules get lumped together? Why or why not?
YEs although it is useful to separate. First, capital acquisitions and repayments relate to financing the business, rather than operations. SEcond, most capital acequisition and repayment cycle accounts involve few transactions, but each is often highly material and therefore should be audited extensively.
What can be said of the inventory and warehousing cycles?
Is closely related to all other cycles especially for a manufacturing company. The sale of finished goods involves the sales and collection cycle. Because inventory is material for most manufactruign companies, it is common to borrow money using invenotyr as security. In those cases, the capital acquisition and repayment cycle is also related to inventory and warehousing.
Why is inventory included as its own cycle?
Inventory is included as a separate cycle both because it is related to other cycles and because for most manufacturing and retail companies inventory is usually highly material, there are unique systems and controls for inventory, and inventory is often complex to audit.
What is true of origins and endings of cycles?
Cycles have no beginning or end except at the origin and final disposition of a company. A company begins by obtaining capital, usually in the form of cash. CAsh is also used to acquire labor. Acquisition and payment and payroll and personnel are similar in nature, but functions are different enough to justify separate cycles.