Audit Exam #3

Front 1

8 balance-related audit objectives

Back 1

1) Existence
2) Completeness
3) Accuracy
4) Classification
5) Cutoff
6) Realizable value
7) Detail tie-in
8) Rights & obligations

Front 2

Primary test for existence:

Back 2

Confirmation; alternative procedure: see whether or not customer pays off balance or request 2nd confirmation

Front 3

Primary test for completeness:

Back 3

Rely on completeness of sales tests of transactions

Front 4

Primary test for accuracy:

Back 4

Confirmation

Front 5

Primary test for cutoff:

Back 5

Rely on timeliness of objective tests of sales transactions

Front 6

If goods are returned, returns should be . . .

Back 6

matched w/ the timing of the sale.

Front 7

Primary test for realizable value:

Back 7

Analyze allowance by reviewing aging of AR

Front 8

Primary tests for detail tie-in:

Back 8

1) Test foot the AR aged trial balance and agree balance to GL & AR master file
2) Trace a sample of balances to supporting documents to verify customer details, balance, & aging of the balance is correct

Front 9

Primary test for rights:

Back 9

Review BOD minutes, discuss arrangements w/ client, & examine any contracts

Front 10

Primary test for presentation & disclosure:

Back 10

Based on results of classification review, determine that FS presentation & disclosure is adequate

Front 11

SAS 67 generally requires confirmations unless one of the following is true:

Back 11

1) AR is immaterial
2) Confirmation would be ineffective because of low response rate or unreliable responses
3) Combined IR & CR is low & substantive evidence can be collected that is sufficient

Front 12

Confirmations are effective in discovering:

Back 12

1) Fictitious accounts (existence)
2) Incorrect amounts (accuracy)

Front 13

Confirmations may help in discovering:

Back 13

Uncollectible accounts (realizable value)

Front 14

Confirmations are NOT effective in discovering:

Back 14

Omitted accounts (completeness)

Front 15

3 types of confirmations

Back 15

1) Positive, blank
2) Positive, completed
3) Negative

Front 16

Positive blank

Back 16

Positive w/ a request for information to be supplied by the recipient (recipient's requested to respond/return the confirmation in all circumstances--whether they agree/disagree)

Front 17

Positive completed

Back 17

Positive w/ the information to be confirmed included on the form

Front 18

Negative confirmation

Back 18

The recipient's requested to respond/return the confirmation only when the information's incorrect; if no response is received, assume accuracy.

Front 19

Confirmation procedures:

Back 19

1) Select type of confirmation to send
2) Auditor selects sample of customers w/ non-zero AR balances to confirm
3) Auditor prepares confirmations & has client sign them
4) Auditor prepares for mailing or closely supervises client
5) Auditor mails from a non-client location
6) Send second & third requests to non-responders to increase response rate (when using positive confirmations)

Front 20

Alternative procedures for non-responses:

Back 20

1) Examine cash receipts journal & bank statements for evidence of payments after year end
2) Examine sales invoice & BOL to establish issuance of invoice & date of billing/shipping to test cutoff & existence

Front 21

Goal of sampling for balances:

Back 21

To determine whether account balance is materially misstated

Front 22

Tolerable misstatement (TM)

Back 22

Misstatement that the auditor will allow in the account, defined for both overstatements & understatements

Front 23

Expected misstatement

Back 23

Expectation before sampling begins ($ amt)

Front 24

Acceptable risk of incorrect acceptance (ARIA)

Back 24

Risk that the auditor is willing to take of accepting the account as fairly stated when it is materially misstated, i.e., when misstatement exceeds TM.

Front 25

ARIA relates to . . .

Back 25

audit effectiveness.

Front 26

Acceptable risk of incorrect rejection (ARIR)

Back 26

Risk that the auditor is willing to take of rejecting the account as materially misstated when it is not.

Front 27

ARIR relates to . . .

Back 27

audit efficiency.

Front 28

Projected misstatement

Back 28

Total estimated misstatement in the population based on sample results.

Front 29

LCL/LMB

Back 29

The lowest estimation of the misstatement in the population.

Front 30

UCL/UMB

Back 30

The highest estimation of the misstatement in the population.

Front 31

What should the auditor do if a population is rejected?

Back 31

1) Have the client adjust the account balance
2) Expand testing in specific areas & have the client adjust its records
3) Increase the sample size
4) Have client correct population & draw a new sample
5) Determine whether there are offsetting errors in other accounts
6) Issue a qualified or adverse opinion

Front 32

Difference estimation

Back 32

Measures total estimated misstatement in a population when there is a recorded value & an audited value for each item in the sample. Project is by account.

Front 33

Monetary unit sampling (dollar unit sampling) projects by . . .

Back 33

each dollar.

Front 34

Average error =

Back 34

net error in sample/# of sampling units

Front 35

If the LCL & UCL both fall completely within the tolerable misstatement range, the auditor ___ accept the conclusion that the population is not misstated by a material amount.

Back 35

can; "There is less than a ___ (ARIA) risk that the misstatement in the account exceeds ___ (TM)."

Front 36

If the LCL, the UCL, or both fall outside the tolerable misstatement range, the auditor ______ accept the conclusion that the population is not misstated by a material amount.

Back 36

cannot; "There is more than a ___ (ARIA) risk that the misstatement in the account exceeds ___ (TM)."

Front 37

What is the effect on n?

Back 37

1) Inc. in ARIA --> dec. in n
2) Inc. in ARIR --> dec. in n

Front 38

UMB =

Back 38

(pop. recorded val.)*(CUER for overstatements)*(misstatement % for overstatements)

Front 39

LMB =

Back 39

(pop. recorded val.)*(CUER for understatements)*(misstatement % for understatements)

Front 40

TER =

Back 40

(TM/MS%)/Pop.

Front 41

Problem w/ MUS:

Back 41

1) Severely biased w/ respect to understatement errors
2) Conservative assumptions may result in large samples

Front 42

What is the connection btwn detection risk in the audit risk model & ARIA?

Back 42

Less risk of incorrectly accepting the account --> dec. DR & inc. audit work

Front 43

MUS is not efficient because . . .

Back 43

there is no offsetting of positive & negative errors, but it is robust to violations of normality, etc.

Front 44

Difference estimation is efficient but biased when . . .

Back 44

few (3 or less) errors are found in the sample.

Front 45

Documents & records in acquisition & payment cycle

Back 45

1) Purchase requisition
2) Purchase order
3) Receiving report
4) Vendor invoice
5) Voucher & check
6) Voucher register/purchases journal
7) AP subsidiary ledger
8) Vendor statement
9) Check
10) Cash disbursements journal/check register

Front 46

Requisitioning:

Back 46

Request for goods or services by an authorized individual from any department or functional area w/in the entity (purchase req.)

Front 47

Purchasing:

Back 47

Execute properly authorized purchase orders (purch. order)

Front 48

Receiving:

Back 48

Responsible for receiving, counting, & inspecting goods received from vendors (rec'v report)

Front 49

Invoice processing:

Back 49

The accounts payable dept. processes invoices to ensure that all goods & services received are recorded & that the corresponding liability is recognized (vendor invoice & voucher packet)

Front 50

Disbursements:

Back 50

Responsible for preparing & signing checks for paying vendors

Front 51

Accounts payable:

Back 51

The accounts payable dept. ensure that all vendor invoices, cash disbursements, & adjustments are recorded in the AP records

Front 52

General ledger:

Back 52

Ensure that all purchases, cash disbursements, & payables are properly accumulated, classified, & summarized in the accounts

Front 53

Vendor's statement

Back 53

A statement prepared monthly by the vendor, which indicates the customer's beginning balance, acquisitions, payments, & ending balance

Front 54

Voucher

Back 54

A document used to establish a formal means of recording & controlling acquisitions, primarily by enabling each acquisition transaction to be sequentially numbered

Front 55

Key controls of the acquisitions & payment cycle:

Back 55

1) Purchases are properly authorized
2) Separation of asset custody from other functions
3) Timely recording of & independent review of transactions
4) Payments are properly authorized

Front 56

TOC/TOT to make sure that purchases are authorized as to amount/quantity:

Back 56

1) For a sample of vouchers recorded in the purchases journal, check for evidence of approval
2) Inquire about authorization limits
3) For a sample of vouchers recorded in the purchases journal, compare purchased amounts to authorization limits

Front 57

TOC/TOT to make sure that purchases are authorized as to vendor:

Back 57

1) Inspect approved vendor list
2) For a sample of vouchers recorded in the purchases journal, compare vendor to approved vendor list

Front 58

TOC/TOT to make sure that purchases are authorized as to price:

Back 58

For a sample of vouchers recorded in the purchases journal, trace to the invoice & compare price billed to the approved price

Front 59

TOC/TOT to make sure that custody of purchased assets is separate from recording:

Back 59

Record & observe regarding conflicting duties in receiving & recording.

Front 60

TOC/TOT to make sure that prenumbered vouchers, receiving reports, purchase orders, & purchase requisitions are used:

Back 60

1) Inspect prenumbered documents
2) Inquire & observe regarding accounting for sequence

Front 61

TOC/TOT to make sure that receiving counts & inspects goods upon arrival:

Back 61

1) Inquire & observe the receiving process
2) For a sample of vouchers recorded in the purchases journal, trace to the receiving report looking for evidence of count & inspection

Front 62

TOC/TOT to make sure that receiving reports, purchase orders, & invoices match as to quantity & type of goods:

Back 62

For a sample of vouchers recorded in the purchases journal, verify the quantity & type of goods billed (per sales invoice) equal quantity & type ordered (per purchase order) & received (per receiving report).

Front 63

TOC/TOT for internal verification of invoice amounts:

Back 63

For a sample of vouchers recorded in the purchases journal, trace to the invoice & reperform footing & cross-footing.

Front 64

What steps are typically involved in a payment transaction?

Back 64

1) Cash disbursements (treasury) processes vouchers for payment (i.e., prepare check)
2) Treasurer (authorized check signer) signs check, cancels voucher packet, & mails check
3) Record payment--accounts payable & cash

Front 65

TOC/TOT to check if custody is separate from recording responsibility:

Back 65

Inquire & observe check signer about conflicting responsibilities.

Front 66

TOC/TOT to make sure payments are authorized:

Back 66

1) Inquire & observe that check signer reviews supporting documents before checks are signed
2) Examine a sample of checks recorded in the cash disbursements journal for indication of approval

Front 67

TOC/TOT to make sure prenumbered checks are used:

Back 67

1) Examine prenumbered checks
2) Inquire about accounting for sequence

Front 68

TOC/TOT to make sure that documents are cancelled to prevent reuse:

Back 68

For a sample of checks recorded in the cash disbursements journal, trace to voucher package for evidence of cancellation.

Front 69

TOC/TOT for internal verification that check amount agrees w/ invoice:

Back 69

For a sample of checks recorded in the cash disbursements journal, trace to the invoice & agree the amount.

Front 70

TOC/TOT to see if monthly bank reconciliations are performed by independent person (no custody or recording responsibility):

Back 70

1) Inquire & observe the bank reconciliation process
2) Reperform a bank reconciliation
3) Examine a sample of bank reconciliations

Front 71

Steps to completing the audit:

Back 71

1) Perform additional tests for presentation & disclosure
2) Review for contingent liabilities
3) Review for subsequent events
4) Accumulate final evidence
5) Evaluate results
6) Issue audit report
7) Communicate w/ audit committee & management

Front 72

Contingent liabilities

Back 72

An existing condition, situation, or set of circumstances involving uncertainty as to a possible obligation that is dependent upon the occurrence or non-occurrence of one or more future events

Front 73

Three standards of likelihood:

Back 73

1) Probable --> record loss if estimable
2) Reasonably possible --> disclose
3) Remote --> do nothing

Front 74

Auditing procedures for contingent liabilities:

Back 74

1) Ask management
2) Review current & previous years' IRS agent reports for income tax settlements
3) Review the minutes of BOD & stockholders' meetings
4) Analyze legal expense for the audit period & review invoices from legal counsel
5) Obtain a letter from each major attorney performing legal services for the client
6) Review working papers for any information that may indicate a potential contingency (bank confirmation may indicate notes receivable discounted or guarantees of loans)
7) Examine letters of credit in force as of the BS date & confirm used & unused balance

Front 75

Purpose of inquiry of client's attorneys:

Back 75

1) Evaluate known litigation or other claims
2) Identify additional litigation & claims

Front 76

Attorneys may be reluctant to provide certain information to auditors due to . . .

Back 76

1) Lack of knowledge
2) Confidential info which may exacerbate a legal loss

Front 77

If an attorney refuses to provide the auditor w/ info about material existing lawsuits (assert claims) & unasserted claims . . .

Back 77

the auditor must modify his/her audit report to reflect the lack of available evidence (no unqualified opinion).

Front 78

A subsequent is one that . . .

Back 78

occurs after the balance sheet date.

Front 79

Direct effect:

Back 79

Conditions that existed at the BS date

Front 80

No direct effect:

Back 80

Conditions that came into being after the end of the year

Front 81

Examples of direct effect subsequent events that require adjustment of financial statements:

Back 81

1) Auditors use subsequent sales activity (e.g., inventory sold as scrap vs. viable product) to provide information regarding inventory valuation at the BS date
2) Bankruptcy by a customer w/ an outstanding AR balance due to deteriorating financial condition
3) Settlement of litigation at an amount different from the amount recorded at YE
4) Disposal of equipment not being used in operations at a price below the current BV

Front 82

No direct effect subsequent events ____ provide evidence of conditions that existed at the BS date but are so significant that they require disclosure even though they do not require adjustment.

Back 82

DON'T

Front 83

Examples of no direct effect subsequent events:

Back 83

1) Decline in the market value of securities held for temporary investment or resale
2) Issuance of bonds or equity securities
3) Decline in the market value of inventory as a consequence of government action barring further sale of a product
4) Uninsured loss of inventories due to fire
5) A merger or acquistion

Front 84

Auditing procedures for subsequent events:

Back 84

1) Inquiries of management
2) Correspond w/ attorneys
3) Review internal statements & records prepared subsequent to BS date
4) Examine minutes of BOD & shareholder meetings isseud subsequent to BS date
5) Obtain a management letter of representation

Front 85

When do you use dual dating?

Back 85

When the auditor determines that a subsequent event occurred after field work was completed but before the audit report was issued.

Front 86

The auditor has two options for expanding SE tests:

Back 86

1) Expand all SE tests to the new date (single date)
2) Restrict the SE review to matters related to the new subsequent event (dual date)

Front 87

Steps for final evidence accumulation:

Back 87

1) Perform final analytical procedures
2) Evaluate the going concern assumption
3) Obtain a management representation letter
4) Read other information in the annual report

Front 88

When the auditor has reservations about the client's ability to continue as a going concern for at least 1 year beyond the BS date, the auditor must:

Back 88

1) Evaluate management's plans to avoid bankruptcy
2) Evaluate the feasibility of achieving

Front 89

Why is the auditor required to obtain a letter of representation?

Back 89

1) To improve upon management its responsibility for assertions in the FS
2) To document the responses from management to inquiries about various aspects of the audit

Front 90

T/F: A management representation letter is considered reliable evidence.

Back 90

FALSE!!

Front 91

4 categories of management representation letter matters:

Back 91

1) Financial statements
2) Completeness of information
3) Recognition, measurement, & disclosure
4) Subsequent events

Front 92

In order to decide whether sufficient evidence has been accumulated to warrant a clean opinion, an auditor must . . .

Back 92

review audit results & evaluate disclosures.

Front 93

If the auditor becomes aware, after the audited FS have been issued, that some information in the FS is materially misstated, the auditor has the obligation to . . .

Back 93

make certain that users who are relying on the FS are informed of the misstatements. The client can inform users, but if they refuse to cooperate, the auditor must notify regulatory agencies & all relying on FS.

Front 94

T/F: Subsequent discovery of facts requiring the recall or re-issuance of FS does NOT arise from business events occurring after the date of the auditor's report.

Back 94

TRUE; FS must be recalled or reissued only when information that would indicate that the FS were not fairly presented already existed at the audit report date.

Front 95

Four categories of audit reports:

Back 95

1) Standard unqualified
2) Unqualified w/ explanatory paragraph or modified wording
3) Qualified
4) Adverse or disclaimer

Front 96

Standard unqualified

Back 96

The five conditions required for a statement unqualified report have been met.

Front 97

Unqualified w/ explanatory paragraph or modified wording

Back 97

A complete audit took place w/ satisfactory results & FS that are fairly presented, but the auditor believes that it is important or is required to provide additional information.

Front 98

Qualified

Back 98

The auditor concludes that the overall FS are fairly presented, but the scope of the audit has been materially restricted or GAAP were not followed in preparing the FS.

Front 99

Adverse

Back 99

The auditor concludes that the FS are not fairly presented.

Front 100

Disclaimer

Back 100

The auditor is unable to form an opinion as to whether the FS are fairly presented or he/she is not independent.

Front 101

7 parts of the standard unqualified report:

Back 101

1) Report title ("independent auditor's report")
2) Audit report address to the company, its stockholders, or the BOD--NOT management!
3) Introductory paragraph
4) Scope paragraph
5) Opinion paragraph
6) Auditor signature
7) Report date (last day of fieldwork)

Front 102

5 conditions for a standard unqualified report:

Back 102

1) All 4 statements are included in FS
2) The three general standards have been followed in all respects on the engagement
3) Sufficient evidence has been accumulated, and the auditor concludes that the three standards of field work have been met
4) The FS are presented in accordance w/ GAAP
5) There are no circumstances requiring the addition of an explanatory paragraph or modification of the wording of the report

Front 103

Causes of explanatory paragraph:

Back 103

1) Lack of consistent application of GAAP
2) Substantial doubt about going on concern
3) Auditor agrees w/ a departure from promulgated accounting principles
4) Emphasis of a matter

Front 104

Cause of modified wording:

Back 104

Reports involving other auditors

Front 105

Consistency-related changes that require EP:

Back 105

1) Changes in accounting principles (LIFO vs. FIFO)
2) Changes in reporting entities (mergers & acquisitions)
3) Corrections of errors involving principles by changing from an accounting principle that's not GAAP to one that is GAAP, including correction of the resulting error

Front 106

Comparability-related changes that do NOT require EP:

Back 106

1) Changes in estimate (useful life)
2) Error corrections not involving princples, such as previous year's math errors
3) Variations in format & presentation of financial info (direct vs. indirect SCF)
4) Changes related to new endeavors/events (entering into new product lines)

Front 107

Factors that give risk to doubt about going concern:

Back 107

1) Significant recurring operating losses for working capital deficiencies
2) Inability of the company to pay its obligations as they come due
3) Loss of major customers, the occurrence of uninsured catstrophes such as earthquake or flood, or unusual labor difficulties
4) Legal proceedings, legislation, or similar matters that have occurred that might jeopardize the entity's ability to operate

Front 108

When the auditor relies on a different CPA firm to perform part of the audit, the principal CPA firm has three alternatives:

Back 108

1) Full responsibility
2) Shared responsibility
3) No responsibility

Front 109

Full responsibility:

Back 109

When another firm audited an immaterial portion of the FS & they did a good job

Front 110

Shared responsibility:

Back 110

When another firm audited a material portion of the FS & the principal CPA couldn't review their work.

Front 111

No responsibility:

Back 111

When there is not enough information to issue a report.

Front 112

Scope limitations can be . . .

Back 112

1) Imposed by the client
2) Caused by circumstances

Front 113

Qualified opinions can result from:

Back 113

1) Scope limitations
2) Failures to follow GAAP

Front 114

A qualified opinion can only be used when the auditor concludes that . . .

Back 114

the overall FS are fairly stated except for one thing.

Front 115

When is an adverse opinion issued?

Back 115

Only when the auditor believes that the overall FS are so materially misleading that they do not present fairly

Front 116

A disclaimer may arise because of:

Back 116

1) A severe limitation on the scope of the audit
2) A nonindependent relationship (under the Code of Professional Conduct) between the client & the auditor
3) A severe going concern problem

Front 117

A __________ can arise only from a lack of knowledge by the auditor whereas an _______ ______ arises when the auditor has knowledge that the FS are not fairly stated.

Back 117

disclaimer, adverse opinion

Front 118

Disclaimers & adverse opinions are only used when the condition is . . .

Back 118

pervasively material.

Front 119

3 levels of materiality:

Back 119

1) Immaterial
2) Material
3) Pervasively material

Front 120

When's an adverse opinion issued for internal controls?

Back 120

When the auditor discovers A material weakness in the internal controls at year end.

Front 121

Sections of an internal control audit report:

Back 121

1) Introductory paragraph
2) Scope paragraph
3) Definitions & limitations paragraph
4) Opinion paragraph