Assurance, Finance,MA Flashcards
Reporting alternatives – Specific items (Assurance)
- CAS 805 Report – Audit of a Single Financial Statement and Specific Elements, Accounts or Items of a Financial Statement
o A report providing audit level assurance on individual financial statements or accounts, rather than financial statements on the whole
o May not be a practical alternative if the financial statements on the whole are not being audited
Review engagements (Assurance)
- The objective of a review engagement is to obtain limited assurance about whether the financial statements as a whole are free from material misstatement
- A conclusion is formed on whether anything has come to the practitioner’s attention to cause them to believe the financial statements are not prepared, in all material respects, in accordance with an applicable financial reporting framework, i.e. ASPE, IFRS
- Limited assurance about the results of the examination is provided, with an explicit statement that an audit opinion is not expressed
- Report expresses negative assurance - “nothing has come to our attention…”
- Similar to an audit, independence is required as it is an assurance engagement
- Materiality must be determined
- Typical procedures include:
o Obtaining knowledge of the client’s business
o Making inquiries of management and client personnel
o Performing analytical procedures
Case: Elder
Opening balances (Assurance)
- Sufficient and appropriate evidence regarding opening balances being free of material misstatement must be obtained in order to issue an opinion
- Evidence may be obtained by reviewing the previous auditor’s working papers, if the client has been audited before, or by performing specified audit procedures on the opening balances, if the client is being audited for the first time
- If the opening balances cannot be verified, it may be necessary to issue a qualified opinion or denial / disclaimer of opinion due to the scope limitation
- Generally, the opening balance scope limitation would not apply to a review engagement as there’s no requirement to send out A/R confirmations or attend inventory counts, which are time-sensitive and generally only required for audit level assurance
Capital Budgeting – Buy vs. Lease (Finance)
- Calculate NPV of each option and compare to determine which option is cheapest
- NPV of buy option – consider:
o Cost of asset
o PV of tax shield
o Maintenance costs - NPV of lease option – consider:
o PV of after tax lease payments - Other factors to consider:
o Impact on covenants
o Cash flows (leasing lessens the current cash burden)
o Leasing may be easier to come by if company has trouble obtaining financing
o Purchasing the asset might provide more flexibility (ownership of asset)
o Leasing might insulate company from severe declines in asset value
o Possible tax advantages (no capital leases for tax purposes – CRA sees all leases the same so cash payments would be deductible, however no CCA)
Financing Options – Debt vs. Equity (Finance)
- Debt financing options:
o Loan- consider loan term, and security/collateral required
o Lease
o Government assistance - Equity financing options:
o Angel investors- can be friends or family looking for a return on investment; generally passive investors
o Venture capitalists- professional investment funds, looking for superior returns (>30%); active participants in management, with a clear exit strategy
o Private equity- tends to participate later in business lifecycle, hence lower risk
o Public markets
Incremental Cash Flows (Finance)
- Incremental cash flows comprise the additional cash flows from taking on a new project, incorporating the tax-affected initial outlay, annual revenues & expenses and terminal value (or cost) associated with the project, in accordance with the scale and timing of the project
- When determining incremental cash flows from a new project, consider:
o Sunk Costs – These are the initial outlays that cannot be recovered even if a project is accepted. As such, these costs will not affect the future cash flows of the project and are not considered incremental
o Opportunity Costs – These represent any potential loss of current cash flows due to accepting a new project and are considered incremental
o Cannibalization – This is the opportunity cost where a new project takes sales away from an existing product
o Working Capital Changes – These represent changes in receivables, payables and inventory due to accepting a new project and are therefore considered incremental
Case: TankCo,
Control Deficiencies (Assurance)
Control Deficiencies (Assurance)
* The most effective format to address controls weaknesses consists of a short statement of the problem (deficiency), its potential effect(s) on the financial statements or operations (implication) and suggestions to address the matter (recommendation)
o Deficiency (D) – this is generally a case fact outlining something that might be deficient with the current controls
o Implication (I) – here, we go beyond case facts to explain the effects of the noted deficiency either on the financial statements or on operations. To the extent possible, effects on the financial statements must be tied to assertions or at least the affected accounts must be outlined along with a discussion of how they might be affected by the deficiency
o Recommendation (R) – this involves suggesting a solution to rectify the noted deficiency that is specific and practical given the case facts and circumstances.
Common audit risk factors (Assurance)
- New or additional users
- Management bias
- Going concern
- Debt covenants
- Cash flow issues
- Control issues
- New problems or issues
- Significant growth in revenues or assets
- Legal claims
- High risk industry
- Complex systems
- Changes in operating environment
- New personnel
- Changes to information systems
- New technologies
- Changes in products or activities
- Corporate restructuring
- Expanded foreign operations
- New accounting pronouncements
Materiality (Assurance)
- A misstatement in financial statements is considered to be material if, in the light of surrounding circumstances, it is probable that the decision of a person who is relying on the financial statements, and who has a reasonable knowledge of business and economic activities (the user), would be changed or influenced
- Common base = 5% of Normalized Net Income before Taxes (NIBT) for profit-oriented entities
- Materiality is not purely quantitative; qualitative factors must be considered
- Factors that may indicate the existence of one or more particular classes of transactions, account balances or disclosures for which misstatements of lesser amounts than materiality for the financial statements as a whole could reasonably be expected to influence the economic decisions of users- i.e. “specific” materiality
- Performance materiality (generally 60% to 75% of materiality) means the amount less than materiality to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality
Audit approach (Assurance)
- If Control Risk assessed at Maximum, then no reliance may be placed on controls, resulting in no Tests of Controls, and a Substantive approach must be followed
- If Control Risk assessed at less than Maximum, then some reliance may be placed on controls, based on results of Tests of Controls, which could lower the amount of substantive work to be done at year-end. Such an approach is generally referred to as a Combined approach
Financial statement assertions (Assurance)
Financial statement assertions (Assurance)
* Assertions about classes of transactions and events for the period under audit:
o Occurrence – transactions and events that have been recorded have occurred and pertain to the entity
o Completeness – all transactions and events that should have been recorded have been recorded
o Accuracy – amounts and other data relating to recorded transactions and events have been recorded appropriately
o Cut-off – transactions and events have been recorded in the correct accounting period
o Classification – transactions and events have been recorded in the proper accounts
o Presentation – transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable
* Assertions about account balances at the period end:
o Existence – assets, liabilities, and equity interests exist
o Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the obligations of the entity
o Completeness – all assets, liabilities and equity interests that should have been recorded have been recorded
o Accuracy, valuation, and allocation – assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded
o Classification – assets, liabilities, and equity interests have been recorded in the proper accounts
o Presentation – assets, liabilities, and equity are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable
Use of an expert (Assurance)
- Evaluate the competence, capabilities and objectivity of the expert
- Obtain an understanding of the expert’s work
- Evaluate the appropriateness of the expert’s work as audit evidence for the relevant assertion
Net Present Value (NPV) vs. Internal Rate of Return (IRR) (Finance)
- The NPV rule states that you invest in any project which has a positive NPV when its cash flows are discounted at the opportunity cost of capital, also known as the discount rate (usually the cost of raising the capital to fund the project)
- The IRR rule states that you invest in any project offering a rate of return which exceeds the opportunity cost of capital
- A project’s rate of return is calculated as the discount rate at which the NPV of the project would be zero
- Therefore, the NPV and IRR rules should give the same accept/reject answer about a project, in most circumstances
- A project’s cash flows should include incremental elements only (i.e. additional sales, associated expenses, lost margin on cannibalization, investment & associated tax-shield, etc., but no financing elements, as discounting of the cash flows already addresses financing)
Discounted vs. Undiscounted Cash Flows (Finance)
- Incremental cash flows (excluding financing elements) should be discounted to recognize the time value of money for the purposes of making a decision regarding accepting or rejecting a project
- Incremental cash flows (including financing elements) should be analyzed year over year, without discounting, to determine if a certain cash position would be met by a certain time
Payback Period (Finance)
- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment
- In general, investments with lower payback period are preferred
- To determine, calculate the cumulative net cash flow for each period and then use the following formula for payback period:
Payback Period = A + B / C, where:
o A is the last period with a negative cumulative cash flow;
o B is the absolute value of cumulative cash flow at the end of the period A; and
o C is the total cash flow during the period after A
Reporting alternatives – Compliance reporting (Assurance)
- CSAE 3530 Report: Attestation engagement — A reasonable assurance or limited assurance engagement to report on management’s statement of an entity’s compliance with agreements, specified authorities, or a provision thereof
o A report concluding on whether management’s stated compliance with the terms of the agreement is fairly stated - CSAE 3531 Report: Direct engagement — A reasonable assurance or limited assurance engagement to report on an entity’s compliance with agreements, specified authorities, or a provision thereof
o A report stating compliance with the terms of the agreement - Section 9100 Report – Results of Applying Specified Auditing Procedures
o A report providing the factual results of the specific procedures that can be chosen to be performed
o No assurance provided but is the most flexible of all alternatives
Methods of collecting audit evidence (Assurance
)
* Inspection – thorough examination of an item by the auditor
* Observation – use of the senses to assess certain activities
* Inquiry – obtain written or oral information from the client in response to questions
* Confirmation – receipt of a written or oral response from an independent third party verifying the accuracy of information
* Recalculation – recheck the computations and mathematical work completed by the client
* Reperformance – redo other non-mathematical procedures such as internal controls
* Analytical procedures – use comparisons and relationships between financial and non-financial information to determine whether account balances appear reasonable
Financial Ratio Analysis
Financial ratios are categorized according to the financial aspect that the ratio measures:
* Liquidity ratios measure the availability of cash to pay short-term debts. E.g., Current ratio, Quick ratio, Working capital ratio
* Asset turnover ratios measure efficiency in utilizing assets. E.g., accounts receivable turnover, inventory turnover
* Profitability ratios measure how well assets are used and expenses are controlled to generate a return. E.g., gross profit margin, net profit
* Debt service ratios measure the ability to repay long-term debt. E.g., debt to equity, times interest earned
Ratios generally are not useful unless they are benchmarked against something else such as past performance or another organization. Therefore, the ratios of organizations in different industries, which face different risks, capital requirements, and competition, are usually hard to compare.
Activity based costing (Management Accounting)
Activity based costing (Management Accounting)
* Costs are allocated to activity cost pools and activity rates are calculated
* Costs that are not driven by activities are not allocated to cost pools
Contribution margin (Management Accounting)
Contribution margin (Management Accounting)
* Contribution margin (CM) is the determination of how much variable profit is available to cover fixed costs and generate a profit.
* CM is highly dependent on the industry and type of business.
* In general, the higher CM, the better.
* To determine CM, calculate the variable revenues per unit (hour, day, year, quantity) offset by the variable costs of the same.
* CM is A – B where:
▪ A is the total variable revenue per unit;
▪ B is the total variable expenses per unit
Break-even analysis (Management Accounting)
- Break-even is the determination of sales volumes necessary to generate a zero-profit.
- Break-even can be expressed in number of units, total revenues, or a percentage of expected revenues.
- To determine, calculate the fixed costs per period, and divide them by the contribution margin (CM) per unit, to determine the necessary sales volumes to generate zero-profit.
- Break-even is A / B where:
▪ A is the total fixed costs;
▪ B is the CM per unit.
Efficiency variance
- Efficiency variance is the difference between the actual unit usage of something and the expected amount of usage. The expected amount is usually the standard quantity of direct materials, direct labour, machine usage time, and so forth that is assigned to a product.
- Efficiency variance = standard price × (actual quantity − standard quantity)
- Using the above formula, positive result is unfavourable; negative result is favourable
Price variance
- Price variance is the difference between the actual cost and standard cost of materials or labour.
- Price variance = actual quantity × (actual price − standard price)
- Using the above formula, positive result is unfavourable; negative result is favourable.
Flexible budget variance
- A flexible budget variance is the difference between the actual costs and standard costs based on the actual production levels.
- Flexible budget variance = actual costs − flexible budget costs (that is, standard quantity of an item for actual units produced × standard price)
- Using the above formula, positive result is unfavourable; negative result is favourable
