9.1 Flashcards
Brown, CPA, has accepted an engagement to audit the effectiveness of the internal control over financial reporting of Crow Company (a nonissuer) and to issue a report on such audit. In what form does Crow present its written assessment about effectiveness?
I. In a separate report that accompanies Brown’s report
II. As a note to the financial statements
I only.
An auditor may audit internal control only if certain conditions are met. One condition is that management provide its assessment about the effectiveness of the entity’s internal control in a report that accompanies the auditor’s report (AU-C 940). Included in the separate report is a condition of accepting the engagement.
During the audit of internal controls integrated with the audit of the financial statements, the auditor discovered a material weakness in internal control. The auditor most likely will express a(n)
Adverse opinion on internal control.
Material weaknesses are significant control deficiencies that result in more than a remote chance that a material misstatement will result in the financial statements. A material weakness requires the auditor to express an adverse opinion on the effectiveness of internal control.
The audit of internal control over financial reporting should test
Design Effectiveness:
Control Effectiveness:
Yes
Yes
The auditor should test design effectiveness by determining whether the controls, if they are operated as prescribed by persons with the necessary authority and competence to perform the control effectively, (1) satisfy the control objectives and (2) can effectively prevent, or detect and correct, fraud or errors that could result in material misstatements in the financial statements. The auditor should test the operating effectiveness of a control by determining whether (1) the control is operating as designed and (2) the person performing the control possesses the necessary authority and competence to perform the control effectively.
Which of the following statements is true about significant deficiencies identified in an audit?
The auditor should identify those significant deficiencies considered to be material weaknesses.
In a financial statement audit, the auditor is not required to perform procedures specifically to identify deficiencies in internal control or to express an opinion on internal control. But the auditor should report significant deficiencies or material weaknesses in internal control of which (s)he becomes aware. In such cases, they must be communicated in writing to management and those charged with governance (AU-C 265).
Which of the following issues related to internal control over financial reporting are required to be communicated in writing to management and those charged with governance?
I. Deficiencies in internal control
II. Significant deficiencies
III. Material weaknesses
II & III only.
Only those control deficiencies considered to be significant deficiencies or material weaknesses are required to be communicated in writing to management and those charged with governance. (But certain deficiencies should not be reported directly to management.) Other control deficiencies that merit management’s attention should be reported to management orally or in writing. A deficiency in internal control exists when the design or operation of a control does not allow management or employees, in the normal course of their assigned functions, to prevent misstatements or detect and correct them on a timely basis. A significant deficiency is a deficiency, or combination of deficiencies, in internal control that is less severe than a material weakness but merits attention by those charged with governance. A material weakness is a deficiency, or combination of deficiencies, in internal control that results in a reasonable possibility that a material misstatement of the financial statements will not be prevented, or detected and corrected, on a timely basis. A reasonable possibility means that the probability of the event is more than remote.
Which of the following matters would an auditor most likely consider to be a significant deficiency or material weakness to be communicated to those charged with governance?
Evidence of a lack of objectivity by those responsible for accounting decisions.
Failures in internal control include deficiencies in internal control design and failures in the operation of internal control. An example of the second type is evidence of undue bias or lack of objectivity by those responsible for accounting decisions (AU-C 265).
Lake, CPA, is auditing the financial statements of Gill Co. Gill uses the EDP Service Center, Inc., to process its payroll transactions. EDP’s financial statements are audited by Cope, CPA, who recently issued a report on EDP’s internal control. Lake is considering Cope’s report on EDP’s internal control in assessing control risk on the Gill engagement. What is Lake’s responsibility concerning making reference to Cope as a basis, in part, for Lake’s own unmodified opinion?
Lake may not refer to Cope under the circumstances above.
The service auditor was not responsible for examining any portion of the user entity’s financial statements. The user auditor therefore should not refer to the service auditor’s report as a basis in part for his or her own unmodified opinion on those financial statements. If the user auditor’s opinion is modified, the service auditor’s work may be referred to if it is relevant to understanding the modification (AU-C 402).
Green, CPA, is auditing the financial statements of Ajax Co. Ajax uses the DP Service Center to process its payroll. DP’s financial statements are audited by Blue, CPA, who recently issued a report on DP’s policies and procedures regarding the processing of other entities’ transactions. In considering whether Blue’s report is satisfactory for Green’s purposes, Green should
Make inquiries about Blue’s professional reputation.
The user auditor should be satisfied about (1) the service auditor’s professional competence and (2) the adequacy of the standards governing the type 1 or type 2 report.
According to the PCAOB, each of the following statements is true with respect to the auditor’s responsibility to communicate material weaknesses in internal control over financial reporting except
All such weaknesses must be communicated in writing to all stockholders.
The auditor only needs to communicate material weaknesses in writing to management and those charged with governance, including the audit committee.
When engaged to express an opinion about the effectiveness of a nonissuer’s internal control over financial reporting, the auditor should
Obtain management’s written representation acknowledging responsibility for establishing and maintaining internal control.
Management should include a written assessment of control effectiveness based on the control criteria. Failure to provide these representations should cause the auditor to withdraw from the engagement.
Snow, CPA, was engaged by Master Co., a nonissuer, to audit the effectiveness of Master’s internal control over financial reporting as part of an integrated audit. Snow’s report should state that
Because of inherent limitations, internal control may not prevent, or detect and correct, misstatements.
The auditor’s report states that because of its inherent limitations, internal control over financial reporting may not prevent, or detect and correct, misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risks that (1) controls may become inadequate because of changes in conditions or (2) the degree of compliance with the policies or procedures may deteriorate (AU-C 940).
Each of the following statements is correct regarding the likely sources of potential misstatements in an integrated audit except
An evaluation of the entity’s information technology risk and controls should be performed separately from the top-down approach.
The auditor begins an integrated audit at the statement level by understanding overall risks to internal control over financial reporting. (S)he then focuses on entity-level controls and works down to significant classes of transactions, account balances, disclosures, and their relevant assertions. The following are examples of entity-level controls: (1) the control environment, (2) controls over management override, (3) monitoring of the results of operations, (4) controls over the period-end financial reporting process, (5) monitoring of other controls, and (6) the risk assessment process.
The auditor is required to communicate each of the following items to those charged with governance except
All control deficiencies detected during the course of the audit.
The auditor should communicate in writing significant deficiencies and material weaknesses, not all control deficiencies, to management and those charged with governance.
Which of the following matters is an auditor required to communicate to those in the entity charged with governance?
I. Disagreements with management about matters significant to the entity’s financial statements that have been satisfactorily resolved
II. Initial selection of significant accounting policies in emerging areas that lack authoritative guidance
Both I & II.
AU-C 260, The Auditor’s Communication with Those Charged with Governance, states that the matters to be discussed include (1) an overview of the planned scope and timing of the audit; (2) the auditors’ responsibilities regarding the audit, such as performing the audit to obtain reasonable, not absolute, assurance about whether the statements are fairly presented; (3) significant accounting policies; (4) sensitive accounting estimates; (5) uncorrected and corrected misstatements; (6) the qualitative aspects of the entity’s accounting practices; (7) significant difficulties during the audit; (8) auditor disagreements with management, whether or not satisfactorily resolved; and (9) any other findings and issues judged to be significant and relevant to those charged with governance. Under the Sarbanes-Oxley Act of 2002, a registered audit firm must communicate (1) critical accounting policies, (2) all alternative treatments of information within GAAP discussed with management, (3) the ramifications of using such treatments, and (4) the treatment preferred by the firm.
Cain Company’s management engaged Bell, CPA, to audit the effectiveness of Cain’s internal control over financial reporting. Bell’s report, which was accompanied by management’s separate report presenting its written assessment about the effectiveness of internal control, described several material weaknesses and potential errors and fraudulent activities that could occur. Subsequently, management included Bell’s report in its annual report to the board of directors with a statement that the cost of correcting the weaknesses would exceed the benefits. Bell should
Disclaim an opinion as to management’s cost-benefit statement.
If the assessment accompanying the auditor’s report includes a statement that the cost of corrective action exceeds the benefits of implementing new controls, the auditor should include language that disclaims an opinion on the cost-benefit statements as the last paragraph of the report. Also, given material weaknesses, the auditor should express an adverse opinion on the effectiveness of internal control.
