1.19.18 Flashcards
In an audit of financial statements of a nonissuer in accordance with GAAS, an auditor is required to
Document the auditor’s understanding of the entity’s internal control components.
Documentation of the understanding of the internal control components is required by GAAS. Its form and extent are influenced by the nature and complexity of the entity’s controls and the extent of the procedures performed by the auditor.
An auditor should obtain an understanding of an entity’s information system, including
Process used to prepare significant accounting estimates.
The auditor should obtain an understanding of the information system, including (1) the classes of significant transactions; (2) the ways those transactions are initiated, authorized, recorded, processed, corrected, transferred to the general ledger, and reported; (3) the accounting records, whether electronic or manual; (4) how significant events and conditions other than transactions are captured; (5) the financial reporting process used to prepare the entity’s financial statements, including significant accounting estimates and disclosures; and (6) controls over journal entries (AU-C 315 and AS No. 2110).
The existence of a related party transaction may be indicated when another entity
Absorbs expenses of the corporation.
Typical related party transactions include interest-free or low interest loans, real estate sales at prices different from appraisal values, nonmonetary exchanges of similar property, and loans with no scheduled terms. Thus, when another entity absorbs the interest cost for a loan or otherwise provides an advantage that would not be characteristic of an arm’s-length transaction, the existence of related parties may be indicated.
A client’s materials purchasing cycle begins with requisitions from user departments and ends with the receipt of materials and the recognition of a liability. An auditor’s primary objective in reviewing this cycle is to
Evaluate the reliability of information generated by the purchasing process.
The auditor should obtain an understanding of internal control. The purpose of internal control is to address business risks that threaten the achievement of the following entity objectives: (1) reliability of financial reporting, (2) effectiveness and efficiency of operations, and (3) compliance with laws and regulations (AU-C 315).
If an auditor is obtaining an understanding of an issuer’s information and communication component of internal control, which of the following factors should the auditor assess?
The classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements.
According to AS 2110, the auditor should obtain a sufficient understanding of each component of internal control over financial reporting to (1) identify the types of misstatements, (2) assess the factors that affect the risks of material misstatement, and (3) design further audit procedures. Thus, the auditor should obtain an understanding of the information system, including the related business processes, relevant to financial reporting. This understanding includes the classes of transactions in the issuer’s operations that are significant to the issuer’s financial statements.
In obtaining an understanding of a manufacturing entity’s internal control concerning inventory balances, an auditor most likely would
Review the entity’s descriptions of inventory policies and procedures.
The auditor should obtain an understanding of the internal control components to plan the audit, including knowledge about the design of relevant controls and whether they have been implemented. Reviewing the entity’s descriptions of inventory policies and procedures helps the auditor understand their design.
Which of the following events least likely would indicate the existence of related party transactions?
Writing off obsolete inventory to net realizable value just before year end.
The following suggest possible related party transactions: (1) exchanging property for similar property in a nonmonetary transaction, (2) borrowing or lending at rates significantly above or below market rates, (3) selling realty at a price materially different from its appraised value, and (4) making loans with no scheduled repayment terms (AU-C 550 and AS 2410).
Which of the following is the best way to compensate for the lack of adequate segregation of duties in a small organization?
Allowing for greater management oversight of incompatible activities.
Complete segregation may not be feasible due to cost-benefit restraints. Compensating controls most likely are established when segregation of duties is not feasible. Typical compensating controls may include more management oversight.
On June 1, Year 1, a CPA obtained a $100,000 personal loan from a financial institution client for whom the CPA provided compilation services. The loan was fully secured and considered material to the CPA’s net worth. The CPA paid the loan in full on December 31, Year 1. On April 3, Year 2, the client asked the CPA to audit the client’s financial statements for the year ended December 31, Year 2. Is the CPA considered independent with respect to the audit of the client’s December 31, Year 2, financial statements?
Yes, because the CPA was not required to be independent at the time the loan was granted.
An attest engagement requires independence as required by AICPA standards. Accountants who perform audits and reviews are required by AICPA standards to be independent. However, a compilation merely assists management in presenting information in the form of financial statements. It does not provide any assurance that no material modifications should be made for them to be in accordance with the applicable reporting framework. Although a compilation is not an assurance engagement, it is an attest engagement (AR-C 60). Furthermore, AICPA standards do not require an accountant to be independent to perform a compilation. But if (s)he is not independent, a final paragraph of the report should so state. Thus, the CPA was not required to be, and was not, independent during Year 1. Because the loan was paid in full during Year 1, the CPA is considered independent with respect to the audit of the client’s Year 2 financial statements. The CPA had no loan from the client during the engagement.
Which of the following controls most likely would help ensure that all credit sales transactions of an entity are recorded?
The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.
The sequential numbering of documents provides a standard control over transactions. The numerical sequence should be accounted for by an independent party. A major objective is to detect unrecorded and unauthorized transactions. Moreover, comparing shipments with the sales journal also will detect unrecorded transactions.
If the auditors plan to use the work of the internal auditors to obtain audit evidence or to provide direct assistance, they should assess the internal auditors’
Competence and objectivity.
If the external auditor decides to use the work of the internal auditors, the competence and objectivity of the internal auditors should be assessed. Assessing competence involves obtaining information about (1) education and experience; (2) professional certification and CPE; (3) audit policies, programs, and procedures; (4) practices regarding assignment of internal auditors; (5) supervision and review of their activities; (6) quality of audit documentation, reports, and recommendations; and (7) evaluation of internal auditors’ performance. Assessing objectivity includes obtaining information about (1) organizational status (the level to which the internal auditors report, access to those charged with governance, and whether these individuals oversee employment decisions related to the internal auditors) and (2) policies to maintain internal auditors’ objectivity concerning the areas audited (AU-C 610).
An auditor referred to the findings of an auditor’s external specialist in the auditor’s report. This may be an appropriate reporting practice if the
Auditor’s report contains a qualified opinion.
The auditor refers to the work of an auditor’s external specialist because it is relevant to a modification of the opinion. In these circumstances, the report should indicate that the reference does not reduce the auditor’s responsibility for the opinion. If the auditor’s report contains an unmodified opinion, the auditor should not refer to the work of an auditor’s specialist (AU-C 620). A modified opinion is a qualified opinion, an adverse opinion, or a disclaimer of opinion (AU-C 705).
An auditor noted that the accounts receivable department is separate from other accounting activities. Credit is approved by a separate credit department. Control accounts and subsidiary ledgers are balanced monthly. Similarly, accounts are aged monthly. The accounts receivable manager writes off delinquent accounts after 1 year, or sooner if a bankruptcy or other unusual circumstances are involved. Credit memoranda are prenumbered and must correlate with receiving reports. Which of the following areas could be viewed as an internal control deficiency of the above organization?
Write-offs of delinquent accounts.
The accounts receivable manager has the ability to perpetrate fraud because (s)he performs incompatible functions. Authorization and recording of transactions should be segregated. Thus, someone outside the accounts receivable department should authorize write-offs.
Which of the following fraudulent activities most likely could be perpetrated due to the lack of effective internal controls in the revenue cycle?
The write-off of receivables by personnel who receive cash permits the misappropriation of cash.
Authorization of transactions (write-offs of receivables) and custody of assets (cash) are incompatible duties.
After obtaining an understanding of internal control, an auditor of a nonissuer’s financial statements may place no reliance on controls for some assertions because the auditor
Believes the controls are unlikely to be effective.
The assessment of risks is a basis for choosing the audit approach. A substantive audit approach is based only on substantive procedures. A combined audit approach applies tests of controls and substantive procedures. For example, the risk assessment procedures may not identify effective controls for the relevant assertion, or testing controls may be inefficient, e.g., because client documentation is not available. The result is that controls are not a factor in the risk assessment. In these cases, if the auditor adopts the substantive audit approach, (s)he needs to be satisfied that it will be effective in reducing audit risk to an acceptable level. For example, the substantive audit approach may not be feasible when the processing of routine transactions is highly automated with little manual intervention. In this case, the combined audit approach is chosen.
