AUD-2 Flashcards
1
Q
What is the primary duty of an auditor?
A
To provide users of financial information with REASONABLE ASSURANCE that the financial statements are not materially misstated.
2
Q
What is the auditor’s responsibility for detecting theft or fraud?
A
Auditors are not responsible for detecting theft or fraud.
Instead- they are responsible for providing REASONABLE ASSURANCE that the financial statements are not materially misstated.
3
Q
When should an auditor be hired in relation to the balance sheet date for optimum audit planning and efficiency?
A
The earlier the auditor is hired- the better for audit planning and efficiency.
4
Q
When can audit procedures be performed at interim dates?
A
If Control Risk for the accounts and/or transactions is low- audit procedures can be performed at interim dates.
The auditor then reviews changes in the balances at year-end.
5
Q
When can an auditor accept an engagement offered after the year is already closed?
A
The auditor can take the engagement if they are able to overcome the limitations of the engagement.
6
Q
For what does an auditor use professional skepticism?
A
To plan the scope of the audit
To plan the objectives of the audit
7
Q
How can analytical procedures be performed in audit planning?
A
The auditor can compare actual versus forecasted numbers.
8
Q
What must an auditor have in order to discuss issues relating to a predecessor auditor’s work?
A
If issues relating to predecessor auditor’s work on previous Financial Statements come up during the current audit- Auditor must have client’s permission to discuss the issue.
9
Q
What questions must an auditor ask with respect to procedures carried out by assistants?
A
Were they adequately performed? (Review the working papers)
Are the results consistent with the audit report?
10
Q
How is audit strategy mapped out?
A
Auditor determines what the reporting objectives are.
Auditor determines the scope of the audit.
11
Q
Describe the key components of maintaining auditor independence.
A
Auditor must be independent in fact and appearance
Honesty
No direct financial interest
No indirect material financial interest
12
Q
Describe Due Professional Care
A
Technical abilities mirror those held by peers in the profession
Follow GAAS Standards
Obtain a Reasonable Level of Assurance
Maintain Reasonable Level of Skepticism
Supervise Audit Staff
Review judgment at every level
13
Q
What should an auditor do prior to accepting an audit engagement?
A
Review the previous financial statements
Speak to third parties
Contact predecessor auditor to evaluate whether engagement should be accepted (must have client permission)
14
Q
What questions should be asked by an auditor prior to taking an engagement?
A
Note: must have permission of client to contact predecessor auditor (no permission = no engagement)
Why the Auditor Change?
Any Serious Discussions with Audit Committee?
How is Management Integrity? Disagreements?
How was Internal Control?
Understand Industry or Be Willing to Learn
Consider Scope Limitation - Limited evidence available = no engagement
15
Q
What should be included in an audit engagement agreement?
A
Note: must be written
Objectives of Engagement
Limitations of Engagement
Responsibilities of Management - Provide written assertions
Responsibilities of Auditor - Limited error/fraud responsibility
Expectations of Access to Records
Financial Statements (and Disclosures) are Management’s Responsibility
Compliance with Laws
Internal Control
16
Q
What is management’s responsibility with respect to the financial statements?
A
Management is responsible for financial statements and adequacy of disclosures.
Presentation & Disclosure
Existence (Tests Overstatements)
Rights & Obligations
Completeness (Tests Understatements)
Valuation & Allocation
17
Q
What is the purpose of the Audit Committee?
A
Responsible for Hiring Auditor
Oversees Internal Control
Must Agree with Auditor on: Responsibility of the Parties- Audit Fee- Timing of the Audit- Audit Plan
Acts as Liaison Between Auditor and the Board
Auditor Communicates Concerns about: Internal Control Deficiencies- Errors- Fraud- Illegal Activities
18
Q
How is Audit Risk calculated?
A
Inherent Risk x Control Risk x Detection Risk
Risk that material mistakes- errors- omissions- or fraud will result in an inaccurate audit report
Based on Auditor Judgment
Measured in both Qualitative and Quantitative
19
Q
Describe Control Risk
A
Risk that internal control will not detect error or fraud
Auditor cannot control this.
20
Q
Describe Inherent Risk.
A
Which transactions have a higher level of risk?
Auditor cannot control
21
Q
Describe Detection Risk.
A
Will the auditor fail to detect a material misstatement?
Auditor CAN control
Do testing at year-end
Increase substantive testing
Run more effective tests
22
Q
What responses should an auditor take based on different levels of acceptable detection risk (DR)? What type of tests should be performed?
A
Less Acceptable DR = Run More Substantive Tests
More Acceptable DR = Run Less Substantive Tests
More Substantive Tests (DR down) = Less Audit Risk; (AR = IR x CR x DR)
Less Substantive Tests (DR up) = More Audit Risk; (AR = IR x CR x DR)
23
Q
What are quantitative measurements versus non-quantitative measurements with respect to risk?
A
Quantitative Measurements - Inherent- Control- and Detection Risk can all be measured in terms of percentages
Non-Quantitative Measurements - Inherent- Control- and Detection Risk can all be measured in terms of acceptable ranges
24
Q
Whose responsibility is it to FIND and PREVENT fraud?
A
It is Management’s responsibility.
25
What is the auditor's responsibility with respect to fraud and illegal acts?
Assess the RISK that such things will lead to material misstatements
Design the audit to provide reasonable assurance against fraud- illegal acts that directly and materially affect the financial statements
Report ALL management fraud to the audit committee (minor fraud by low-level employees not reported to committee)
Perform required inquiries and procedures (management inquiries- analytical procedures- discussions with audit personnel about fraud)
26
What are the three factors that affect/influence fraud?
Fraud is born out of:
Rationalization
Incentive
Opportunity
(RIO)
27
What is the difference between fraud and errors?
Errors are unintentional- fraud is intentional.
28
What red flags may indicate higher risk in an audit?
Management compensation tied to stock
Aggressive financial forecasting
Former auditor disagreed with Management
Records not available for audit
Current audit procedures may need to be reconsidered if red flags exist.
29
Describe the characteristics of a Fraud Risk Factor.
Has been observed in similar situations
Does NOT necessarily mean that there is a material weakness in internal control
Leads to an auditor taking action
30
What does an examination of internal control accomplish with respect to illegal acts?
Internal control analysis can result in the conclusion that IC is weak- but probably won't identify illegal acts
31
What is the purpose of adjusting audit procedures in light of fraud risk factors identified during an audit?
Strives to make audit engagement procedures less patterned and predictable
Re-evaluates management's application of accounting procedures
Finds and assigns audit personnel with relevant skills in this area
32
What should be documented with respect to fraud risk factors in an audit?
Any fraud risks identified that could lead to material misstatement
Audit procedures performed to assess risks
Nature of communication made to audit committee and company management
Disclosure to third parties regarding fraud not normally the auditor's responsibility
Fraud by management should normally be reported to the audit committee- NOT the SEC.
33
What was the effect of the SOX Act of 2002?
Created PCAOB
Designates Officer responsibility for internal control
Must disclose significant internal control weaknesses to auditor and audit committee
Must disclose any level of fraud discovered by employees with internal control responsibilities
34
What is the Hierarchy of Authoritative Literature?
1. Statements on Auditing Standards (SAS)
2. Auditing Interpretations- AICPA Guides & SOPs
3. Industry Articles (no authority)
35
What quality control activities are undertaken by CPA firms with audit practices?
Firm Leadership exhibits quality and leads by example and sets the tone for the organization
Firm should Monitor and document that its policies and procedures are being followed
Firm should have Relevant Ethical Requirements
Acceptance and continuance of client engagements should continue to be evaluated for client integrity- auditor competency- and legality
Firm should have competent and ethical personnel
Firm engagements are performed- supervised- and reviewed in accordance with professional standards and regulations.
36
Which literature governs Compilation services?
SSARS - Statements on Standards for Accounting and Review Services
These govern reporting for non-public entities only
37
What is the independence requirement for Compilations?
Independence NOT required for Compilations
No Internal Control work allowed
No assurance given
38
What type of assurance is provided by a Compilation?
Compilations are not an assurance service. No assurance is provided.
39
What type of assurance is provided by Review services?
Reviews provide NEGATIVE assurance.
40
What is the independence requirement for a Review?
Reviews require independence.
No Internal Control work allowed
Performs analytical procedures
No material indirect financial interest allowed
No immaterial direct financial interest allowed
41
For compilations and reviews- what knowledge must a service provider have?
Must have an understanding of the client industry.
42
What are attestation services?
CPA expresses a conclusion about an assertion - Compliance with laws
NOT considered a Consulting engagement
Independence Required
43
What is the independence requirement for consulting services?
Independence is not required for consulting services.
44
Describe the limitations on Prospective Financial Statements?
Report is restricted to specified users.
Agreed-upon procedures are implemented.
45
What is the role of the Group Engagement Team?
Develop Audit Strategy; Communicate with Component Auditors; Perform work on the Consolidation Process; Evaluate Audit Conclusions; Understand work of Component Auditors;
46
Who is on the Group Engagement Team?
Firm Partners; Group Engagement Partner; Audit Staff
47
Who establishes the Materiality threshold for the Component Auditor?
The Group Engagement Team; The Materiality threshold must be lower than the Group Materiality threshold
48
What is the Group Engagement Partner responsible for?
Group Audit Engagement Direction - Supervision - Performance and the Audit Report
49
What is the role of a Component Auditor
Audit a component of the entity
50
What should the Group Engagement Team do if a Component Auditor audits a Significant Component due to Financial Materiality?
Audit the Financial Information
51
What should the Group Engagement Team do if a Component Auditor audits a Significant Component due to Risk of Material Misstatement?
Perform Audit Procedures
52
What should the Group Engagement Team do if a Component Auditor audits a Non-Significant Component?
Analytical Procedures performed at Group Level
53
Why does an Auditor do if they suspect legal proceedings could contribute to a Material Misstagement?
Contact Client external counsel through a Letter of Inquiry
54
What is the majority of an auditor's work in determining an audit opinion?
Collection of evidence to support the opinion.
55
Of what does audit Evidence consist?
Evidence consists of client accounting data and supporting documentation from client or from third parties.
56
What is the relationship between Evidence and Detection Risk?
Evidence has an inverse relationship with Detection Risk
The one aspect of Audit Risk an auditor can control through (N)ature (T)iming (E)xtent of audit procedures.
Inherent Risk and Control risk are outside of auditor's control.
57
Which aspects of Audit Risk can an auditor control?
Detection Risk which is decreased by gathering evidence.
58
Which aspects of Audit Risk can an auditor NOT control?
Inherent Risk and Control Risk are outside of an auditor's control.
59
How does a high level of acceptable Detection Risk affect an audit?
Less Evidence collected. Opens door for incremental audit risk - Internal Control should be strong.
Business and transactions should be relatively stable and predictable.
(N) Less-competent Evidence collected
(T) Interim testing acceptable
(E) Fewer transactions are verified.
60
What should occur when a low level of Detection Risk is acceptable?
More Evidence collected
(N) More-competent Evidence collected
(T) End of year balance testing
(E) More transactions are verified
61
What are the primary risks in an audit for a typical for-profit company?
Auditors are there to verify that
Assets & Revenues are not overstated
Expenses & Liabilities are not understated
Exception - if the CPA Exam states that it is a tax-driven company flip them around
62
What is the primary constraint on audit evidence?
Cost vs. Benefit is a primary constraint.
63
What characteristics should audit evidence have?
Sufficient (quantity)
Appropriate: Relevant & Reliable (Quality)
64
How does the quality of audit evidence vary depending on who has provided it?
Best evidence: Observation of activity by auditor.
2nd Best: Originates from External Parties and is sent directly to auditor (or failing that items are generated by third party and provided to auditor by the client such as a bank statement)
Weakest: Oral evidence from management.
65
Which documents are the most persuasive and credible?
Third party documents are more persuasive and credible than internally-prepared docs
Auditor Knowledge = Most Persuasive
3rd Party info given to auditor
3rd Party info given to client
Internally-prepared doc
66
What are Substantive Procedures?
Test substance/amounts/values. They help to reduce the risk of material misstatements. They only test accuracy of financial statements and dollar amounts - they don't test internal controls.
67
What are the substantive tests that are most often performed?
```
Trace (or Vouch)
Reconcile
Analytical Procedures
Confirmations
Examine evidence that supports management assertions.
```
(T.R.A.C.E.)
68
When performing audit procedures what should auditors focus on?
Auditors focus first on Balance Sheet Accounts then associated Income Statement items
69
How is Cash audited?
Assurance Level is High.
Acceptable Detection Risk is Low.
70
How is Accounts Receivable audited?
If Acceptable DR is High - Negative Confirmation is used - Customer only responds if balance is materially wrong.
If Acceptable DR is Low - Positive Confirmation is used - Customer asked to confirm by telling auditor the balance.
Corresponding Income Statement Account - Revenue
71
How is Accounts Payable audited?
Review purchase orders/invoices
Confirm with Vendors
Corresponding Income Statement Account - Various Expenses
72
How is Inventory audited?
Examine purchase agreements
Look at Board Minutes
Is Inventory held as collateral?
Corresponding Income Statement Account - COGS
73
How are beginning balances audited?
Should match last year's ending balance.
74
What is the general presumption for auditing Ending Balances?
If Beginning Balance Additions Subtractions are OK then Ending Balances should also be OK.
75
How is a Statement of Cash Flows audited?
Foot all balances - Check the Math
Trace Cash Flow items to other Financial Statements
Check classifications - Operating Activities Investing Activities Financing Activities
76
Under the Indirect Method what must be disclosed on a Statement of Cash Flows?
Interest Paid
Income Taxes Paid
Non-cash Transactions
Cash and Cash Equivalents Definitions
77
Under the Direct Method what must be disclosed on a Statement of Cash Flows?
Results as if you had used Indirect Method
Non-cash Transactions
Cash and Cash Equivalents Definition
78
What are Subsequent Events and what do they require?
Subsequent events occur after the Balance Sheet Date but before the audit report is issued.
Auditor needs to make inquiries and assess if they affect the audit report.
79
What should occur if the audit report has already been issued and the auditor becomes aware of a situation that was present as of the Balance Sheet date (a subsequent event)?
If audit report has already been issued and auditor becomes aware of a situation that was present as of the BS date client should issue a disclosure to financial statement users and/or revise the financial statement.
Regulatory agencies might need to get involved under some circumstances.
80
What should an auditor do if they discover they have forgotten to perform a substantive procedure?
If auditor discovers that they forgot to perform a substantive procedure auditor should determine if other substantive procedures performed served as a substitute.
Otherwise support for their audit opinion could be jeopardized.
81
When are Analytical Procedures required?
REQUIRED When planning the audit (preliminary)
REQUIRED When reviewing the audit (final)
Analytical procedures may be also performed optionally along with the substantive testing.
Use of Analytical Procedures in the audit must be documented.
82
How do Analytical Procedures assist the auditor?
Helps the Auditor:
Determine if Management Assertions are reasonable
Develop audit plan
Develop some expectations about the financial statement and hopefully bring to light any glaring errors on financial statement
83
What is the focus of Analytical Procedures?
Analytical Procedure focus is on dollar amounts (not internal controls)
Analyzes Financial Data: Do Financial Statements Make Sense?
Comparison of data between years
84
How is the Current Ratio calculated?
Current Ratio = Current Assets / Current Liabilities
85
How is the Quick Ratio calculated?
Quick Ratio = Liquid Assets / Current Liabilities
86
How is the Asset Turnover calculated?
Asset Turnover = Net Sales / Average Assets
87
How is the Inventory Turnover calculated?
Inventory Turnover = COGS / Average Inventory
88
How is Gross Margin % calculated?
Gross Margin % = Gross Margin / Sales
89
What type of testing are ratios?
Ratios are Analytical Procedures
90
What type of procedure is a Budget vs. Actual comparison?
Budget vs. Actual comparisons are Analytical Procedures.
91
List Common Types of Analytical Procedures
Ratio analysis
Budget vs. Actual comparison
Comparison of data between years
Use of non-financial data to predict expected values for financial data
92
How do management assertions affect the audit?
Management assertions help the auditor to plan the audit and select substantive tests.
93
What assertions do auditors test?
Presentation - Cutoff Classification - Is it in the right period and category?
Existence/ Occurrence - Did it happen? Does it exist?
Rights & Obligations - Does the company own them?
Completeness - Was everything recorded?
Valuation - Are they worth the amount at which they are recorded?
(PERCV)
94
What assertions are tests for transaction classes?
Occurrence
Cutoff
Classification
Completeness
Accuracy
95
For which assertions are disclosures tested?
Occurrence
Completeness
Classification
Accuracy
96
Is testing the validity of direct evidence a basic audit procedure?
No it is an extended procedure.
For example you don't have to take a loan covenant document and go search out that it's a valid loan covenant. Instead you consider the source - if it's externally prepared it's more persuasive.
97
How are Management Estimates audited?
First and foremost you need to understand management's rationale and methods for developing estimates before you can judge reasonableness.
Next Auditor should formulate their own opinion on what a good estimate should be and compare it.
Finally determine if subsequent events affect the estimate.
98
Whose property are audit documentation (audit workpapers)? In what form must they be?
Audit workpapers are the property of the auditor.
They can be paper or electronic.
They must include a WRITTEN audit program (either paper or electronic).
99
What is the Current File?
Information pertaining to the current year's audit.
100
What is the Permanent File?
Information used for this audit and future audits which is updated as needed.
101
How long must audit workpapers be maintained?
Must be kept for 5 years after the audit release date or according to regulations whichever is longer.
Must be kept for 7 years under PCAOB Audit
PCAOB audits also require an Engagement Completion Document
102
What is the primary requirement for audit workpapers besides being written?
Any experienced auditor should be able to look at your work and understand what you did.
103
How should documents added to work papers be treated?
If further documents are added to the work papers after the audit report is issued it must be documented as to who added them why they were added and any effects on the audit report.
104
How should documents removed from workpapers be treated?
After the audit report is released the firm has 60 days to subtract from the file.
You can still add to the file if you document it but you cannot delete any information after 60 days.
Note - for SEC auditors the PCAOB only allows deletions up to 45 days after issuance of the audit report.
105
What does an audit procedures should be applied to Required Supplementary Information?
The auditor should make management inquiries about RSI and obtain written assertions regarding its preparation. The auditor should compare the RSI to the rest of the financial statements to ensure consistency.
106
When is an audit of IT NOT required?
Controls are redundant to another department
The system does not appear to be reliable and testing controls would not be an efficient use of time
Costs exceed benefit
107
When can an audit of IT be performed without directly interacting with the system?
System isn't complex or complicated
System output is detailed
108
What is the role of a Database Administrator?
Maintains database
Restricts access
Responsible for IT internal control
109
What is the role of a Systems Analyst?
Recommends changes or upgrades
Liaison between IT and users
110
What is the role of the data Librarian?
Responsible for disc storage
Holds system documentation
111
What is the benefit of Generalized Audit Software in an audit?
Uses computer speed to quickly sort data and files- which leads to a more efficient audit
Compatible with different client IT systems
Extracts evidence from client databases
Tests data without auditor needing to spend time learning the IT system in detail
Client-tailored or commercially produced
112
What is a Relational Database?
Group of related spreadsheets
Retrieves information through Queries
113
What is a Data Definition Language?
A language that defines a database and gives information on database structure.
It maintains tables- which can be joined together.
It establishes database constraints.
114
What functions are performed by a Data Manipulation Language?
Maintains and queries a database
Auditor needs information- so client uses DML to get the information needed
115
What functions are performed by a Data Control Language?
A Data Control Language controls a database and restricts access to the database.
116
What are Check Digits?
A numerical character consistently added to a set of numbers.
It makes it more difficult for a fraudulent account to be set up or go undetected.
117
What is the purpose of a Code Review?
A Code Review tests a program's processing logic.
Advantageous because auditor gains a greater understanding of the program.
118
What is the purpose of a Limit Test?
Examines data and looks for reasonableness using upper and lower limits to determine if data fits the correct range.
Did anyone score higher than 100%?
119
What is the Test Data Method?
Auditor processes data with client's computer - fake transactions are used to test program control procedures.
Each control needs to only be tested once
Problem with this method - fake data could combine with real data.
120
How can Operating Systems Logs be utilized during an audit?
Auditor can review logs to see which applications were run and by whom.
121
What is the purpose of Access Security Software?
Helpful in online environments
Restricts computer access - may use encryption.
122
How can Library Management Software assist with an audit?
Library Management Software logs any changes to system/applications etc.
123
How can Embedded Audit Modules in software be utilized in an audit?
Assist with audit calculations
Enable continuous monitoring in an audit environment that is changing
Weakness: requires implementation into the system design
Example: SCARF - Collects information based on some criteria and can be analyzed at a later time (necessary because the audit environment is continually changing)
124
What is an Audit Hook?
An Audit Hook is an application instruction that gives auditor control over the application.
125
What is the purpose of Transaction Tagging?
Transaction Tagging allows logging of company transactions and activities.
126
How do Extended Records assist in audit trail creation?
Extended Records add audit data to financial records.
127
How does Real Time Processing affect an audit?
Destroys prior data when updated
aka Destructive Updating
Requires well-documented Audit Trail
128
What is the risk of auditing System outputs versus Application outputs?
If the auditor only audits the outputs of a computer system and doesn't also audit the software applications- an error in the applications could be missed.
129
What is a Compiler?
Software that translates source program (similar to English) into a language that the computer can understand
130
How is Parallel Simulation utilized during an audit?
Client data is processed using Generalized Audit Software (GAS)
Sample size can be expanded without significantly increasing the audit cost
GAS output compared to client output
131
What does auditing internal control in a company's IT environment accomplish?
Plan the rest of audit- Shorter audit trails that may expire- Less documentation
Assess the level of Control Risk - Unauthorized access to systems or data is more difficult to catch
Systems access controls adds another layer to separation of duties analysis
Focus should be on the general controls- new systems development- current systems changes- and program or data access control or computer ops control changes
132
If Internal Control is poor and a company's accounting practices are sloppy - which risk is higher?
Control risk increases with poor Internal Controls and sloppy accounting practices.
133
If Internal Control is poor - what is the effect on the audit?
Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.
134
What does Internal Control provide reasonable assurance for?
Internal control provides reasonable assurance that
Material misstatements will be prevented
Reliability/integrity of financial statements will be preserved
Assets are protected against misuse
135
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose Internal Control deficiencies
Management must provide assessment of Internal Control
Management must certify Financial Statements
136
What is the relationship between Internal Control and Substantive Testing?
Inverse Relationship
Stronger Internal Controls - Less Testing Needed
Weaker Internal Controls - More Testing Needed
137
What are the 3 objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
138
What are the 5 components of Internal Control?
Control Environment
Risk Assessment
Information and Communication
Monitoring
Control Activities
139
What is the purpose for a Control Environment assessment?
Sets tone for the entire company
140
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resource Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
141
What does an auditor's assessment of Detection Risk determine?
Detection Risk determines nature- timing- and extent of audit procedures.
142
What determines the acceptable level of Detection Risk?
Risk of material misstatement determines acceptable level of Detection Risk
143
What items could increase the risk of material misstatement?
Rapid growth in the company.
The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence
Major changes to operations- personnel- systems- IT- products- corporate organization- and foreign operations.
144
What happens when Control Risk is assessed to be at the maximum level?
No Internal Control testing is performed.
All audit procedures are increased in intensity to compensate for increased risk.
145
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
146
Describe some common examples of Control Activities.
Performance Reviews
Information Processing
Physical Controls
Segregation of Duties
147
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external reporting process
148
How must an auditor document understanding of Internal Control?
Through written documentation such as Internal Control memos- flowcharts- and questionnaires
149
What questions should be asked to determine the risk of material misstatement?
Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?
150
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected- substantive procedures do not need to be adjusted
151
When can controls tested by an auditor in a prior year be used in the current year's audit assessment?
Controls tested by auditor in a prior year can be used in the current year's audit assuming they are re-tested every third year
Exception If the control has changed since the last audit
152
What happens if Internal Controls are deficient?
Control Risk increases
Scope of substantive procedures increases
Detection Risk decreases
Material Weakness - Reasonable possibility that a material misstatement in Financial Statements would not be found- more than a remote chance of occurrence
153
What is a Material Weakness?
Reasonable possibility exists that a material misstatement in Financial Statements would not be found- and has more than a remote chance of occurrence.
154
What does Tracing test?
Tests Completeness
Starts with source document and traces forward to the journal entry.
155
What does Vouching test?
Tests Existence.
Starts with a journal entry and searches for a voucher or source document to support the entry.
156
What activities represent Segregation of Duties?
Non-compatible duties performed by separate individuals- such as
Authorization of asset disbursement vs. Recording of Assets vs. Custody of assets
If supporting audit evidence doesn't exit - use Observation and Inquiry
Accounting should be segregated from Production
157
With respect to signing checks - how are duties segregated?
Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS
Tip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves
158
With respect to custody of assets - how should duties be segregated?
Employees who have custody of assets should not also RECORD those assets
Someone in charge of petty cash should not also control the petty cash records
Treasury Department (custodians) should NOT have record keeping duties
They control assets and should not be able to adjust any recording of those assets
159
What are the limitations on Control Activities?
Controls can't stop collusion or bad judgment
Management can override controls
Cost vs. Benefit relationship of Internal Control
160
What is required if a Material Weakness is identified?
A written report to management is required.
Report declaring that no material weaknesses were found is allowed
Previous weaknesses reported that still exist should be reported again
Should be reported no later than 60 days after audit report release date
If one or more material weaknesses is uncorrected at year-end- an Adverse Opinion on Internal Control must be given
161
What is the effect of a Significant Deficiency? What is it?
A significant deficiency adversely affects a company's ability to report in the financial statements according to GAAP.
A significant deficiency is a more than a remote likelihood of material misstatement by more than an inconsequential amount
162
What must occur if a Significant Deficiency is identified?
If a Significant Deficiency is identified- a written report to management required
Report declaring that no significant deficiencies exist is not allowed
Previous deficiencies reported that still exist should be reported again
Should be reported no later than 60 days after the audit report release date
163
What is a Control Deficiency?
A control is not operating as intended.
164
What must an auditor ask if using the work of third parties?
Are they competent?
Are they objective?
165
What must an auditor understand with respect to internal auditors?
Auditor needs to understand the role of Internal Auditors within the organization because their work affects the audit plan
Responsibility for judgments about materiality or appropriateness of entries or estimates cannot be shared with third parties like Internal Auditors
Internal Auditors should be asked to do some of the legwork like preparing schedules or running reports
They should not be asked to make any decisions or judgments
166
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose deficiencies
Management must provide assessment of Internal Controls
Management must certify Financial Statements
167
What is the relationship between Internal Control and Substantive Testing?
Has inverse relationship
Stronger Internal Control results in LESS substantive testing
Weaker Internal Control leads to MORE substantive testing
168
What are the three objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
169
What are the five components of Internal Control?
Control Activities
Risk Assessment
Information and Communications
Monitoring
Control Environment
170
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resources Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
171
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
172
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external communication process
173
How must an auditor document understanding of Internal Control?
Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires
174
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected - substantive procedures do not need to be adjusted
175
If Internal Control is poor and a company's accounting practices are sloppy - which risk is higher?
Control risk increases with poor Internal Controls and sloppy accounting practices.
176
If Internal Control is poor - what is the effect on the audit?
Auditor will need to perform more testing and dig deeper into accounts in order to arrive at an opinion regarding the financial statements.
177
What does Internal Control provide reasonable assurance for?
Internal control provides reasonable assurance that
Material misstatements will be prevented
Reliability/integrity of financial statements will be preserved
Assets are protected against misuse
178
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose Internal Control deficiencies
Management must provide assessment of Internal Control
Management must certify Financial Statements
179
What is the relationship between Internal Control and Substantive Testing?
Inverse Relationship
Stronger Internal Controls - Less Testing Needed
Weaker Internal Controls - More Testing Needed
180
What are the 3 objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
181
What are the 5 components of Internal Control?
Control Environment
Risk Assessment
Information and Communication
Monitoring
Control Activities
182
What is the purpose for a Control Environment assessment?
Sets tone for the entire company
183
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resource Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
184
What does an auditor's assessment of Detection Risk determine?
Detection Risk determines nature- timing- and extent of audit procedures.
185
What determines the acceptable level of Detection Risk?
Risk of material misstatement determines acceptable level of Detection Risk
186
What items could increase the risk of material misstatement?
Rapid growth in the company.
The methods management uses to identify risk- estimate its significance and assess the likelihood of occurrence
Major changes to operations- personnel- systems- IT- products- corporate organization- and foreign operations.
187
What happens when Control Risk is assessed to be at the maximum level?
No Internal Control testing is performed.
All audit procedures are increased in intensity to compensate for increased risk.
188
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
189
Describe some common examples of Control Activities.
Performance Reviews
Information Processing
Physical Controls
Segregation of Duties
190
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external reporting process
191
How must an auditor document understanding of Internal Control?
Through written documentation such as Internal Control memos- flowcharts- and questionnaires
192
What questions should be asked to determine the risk of material misstatement?
Were all transactions recorded?
Were they timely?
Measured appropriately?
Recorded in correct period?
Presented and disclosed properly?
Did Management communicate their responsibilities?
193
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected- substantive procedures do not need to be adjusted
194
When can controls tested by an auditor in a prior year be used in the current year's audit assessment?
Controls tested by auditor in a prior year can be used in the current year's audit assuming they are re-tested every third year
Exception If the control has changed since the last audit
195
What happens if Internal Controls are deficient?
Control Risk increases
Scope of substantive procedures increases
Detection Risk decreases
Material Weakness - Reasonable possibility that a material misstatement in Financial Statements would not be found- more than a remote chance of occurrence
196
What is a Material Weakness?
Reasonable possibility exists that a material misstatement in Financial Statements would not be found- and has more than a remote chance of occurrence.
197
What does Tracing test?
Tests Completeness
Starts with source document and traces forward to the journal entry.
198
What does Vouching test?
Tests Existence.
Starts with a journal entry and searches for a voucher or source document to support the entry.
199
What activities represent Segregation of Duties?
Non-compatible duties performed by separate individuals- such as
Authorization of asset disbursement vs. Recording of Assets vs. Custody of assets
If supporting audit evidence doesn't exit - use Observation and Inquiry
Accounting should be segregated from Production
200
With respect to signing checks - how are duties segregated?
Employees who prepare vouchers/invoices should not also have the authority to SIGN CHECKS
Tip - Remember this as an underlying theme with Segregation of Duties. The authority to make a payment should not also lie in the hands of those creating invoices/vouchers. Why? People commit fraud by setting up fake companies and basically paying themselves
201
With respect to custody of assets - how should duties be segregated?
Employees who have custody of assets should not also RECORD those assets
Someone in charge of petty cash should not also control the petty cash records
Treasury Department (custodians) should NOT have record keeping duties
They control assets and should not be able to adjust any recording of those assets
202
What are the limitations on Control Activities?
Controls can't stop collusion or bad judgment
Management can override controls
Cost vs. Benefit relationship of Internal Control
203
What is required if a Material Weakness is identified?
A written report to management is required.
Report declaring that no material weaknesses were found is allowed
Previous weaknesses reported that still exist should be reported again
Should be reported no later than 60 days after audit report release date
If one or more material weaknesses is uncorrected at year-end- an Adverse Opinion on Internal Control must be given
204
What is the effect of a Significant Deficiency? What is it?
A significant deficiency adversely affects a company's ability to report in the financial statements according to GAAP.
A significant deficiency is a more than a remote likelihood of material misstatement by more than an inconsequential amount
205
What must occur if a Significant Deficiency is identified?
If a Significant Deficiency is identified- a written report to management required
Report declaring that no significant deficiencies exist is not allowed
Previous deficiencies reported that still exist should be reported again
Should be reported no later than 60 days after the audit report release date
206
What is a Control Deficiency?
A control is not operating as intended.
207
What must an auditor ask if using the work of third parties?
Are they competent?
Are they objective?
208
What must an auditor understand with respect to internal auditors?
Auditor needs to understand the role of Internal Auditors within the organization because their work affects the audit plan
Responsibility for judgments about materiality or appropriateness of entries or estimates cannot be shared with third parties like Internal Auditors
Internal Auditors should be asked to do some of the legwork like preparing schedules or running reports
They should not be asked to make any decisions or judgments
209
What is required in an examination of Internal Control under Sarbanes-Oxley?
CEO/CFO must disclose deficiencies
Management must provide assessment of Internal Controls
Management must certify Financial Statements
210
What is the relationship between Internal Control and Substantive Testing?
Has inverse relationship
Stronger Internal Control results in LESS substantive testing
Weaker Internal Control leads to MORE substantive testing
211
What are the three objectives of Internal Control?
Reliability of Financial Reporting
Operational Efficiency/Effectiveness
Compliance with Law and Regulations
212
What are the five components of Internal Control?
Control Activities
Risk Assessment
Information and Communications
Monitoring
Control Environment
213
What are the components of the Control Environment?
Integrity/Ethics of Management
Competence of Management
Organizational Structure
Human Resources Policies
Assignment of Authority/Responsibility
Management's Style (riskier with a dominant/aggressive individual)
Board/Audit Committee involvement
214
What happens when Control Risk is below the maximum level?
Auditor tests Internal Controls.
Auditor evaluates Control Risk based on tests
Auditor adjusts substantive tests accordingly
Weaker Internal Control - More substantive tests
Stronger Internal Control - Less substantive tests
215
What should an auditor understand with respect to Information and Communication on an audit?
Understand Client's
Major transaction classes
Transaction initiation
Support records/documents
Transaction processing
Financial Statement internal reporting process
Financial Statement external communication process
216
How must an auditor document understanding of Internal Control?
Auditor must document understanding of Internal Control via Memos - Flowcharts - Questionnaires
217
What is the purpose of testing Internal Controls?
Auditor needs reasonable assurance that controls are functioning as designed and effective
Internal Control Testing should be strong as (IRON) so that nothing gets past them
Inquiry - Interview company personnel
Re-performance - Can it be replicated?
Observation - Watch the control be applied
INspection - Dig into the details/documents
If results are as expected - substantive procedures do not need to be adjusted
218
Who created the International Auditing Standards?
The International Auditing and Assurance Standards Board (IAASB)
Member of the International Federation of Accountants (IFAC)
219
For whom were IAASB International Auditing Standards created?
IAASB standards are for countries that don't have their own standards and help set the tone for the rest of the members who do have their own standards (AICPA)
IAASB doesn't override member standards
220
What financial approach is used under IAASB audit standards?
IAASB standards are based on a risk assessment approach
221
How do IAASB audit standards compare to US audit standards?
IAASB - No Internal Control audits
IAASB - No Referencing another Audit Firm
IAASB - Less detailed documentation
IAASB - Required: obtain written fraud assessment
IAASB - Required: location of auditor's home office
222
What are International Ethical Standards?
Standards set by International Ethics Standards Board for Accountants (IESBA)
Code of Ethics for Professional Accountants - Similar to AICPA Code of Professional Conduct
223
Which groups are covered under the three sections of the International Ethical Standards?
A) Covers all accountants
B) Covers Public accountants
C) Covers accountants in a business environment
224
What are the requirements for all accountants under the International Ethical Standards?
Accountants should have Integrity
Accountants should be Objective
Accountants should have Competence
Accountants should exercise Due Care
Accountants should maintain Confidentiality
Accountants should act Professionally
225
What questions should public accountants pose to themselves under the International Ethical Standards?
What are the threats/safeguards?
Does this new client threaten our ethics?
What are the conflicts of interest?
What are the threats/safeguards for offering a second opinion?
What are the threats/safeguards for receiving commissions or contingent fees?
Is our marketing truthful?
What are the threats/safeguards for receiving client gifts?
What are the threats/safeguards to objectivity?
226
What engagements are covered by the AICPA Code of Professional Conduct?
Covers all professional engagements and is the minimum standard of conduct
Member should additionally follow specific standards for a specific engagement
227
What must an accountant have under the AICPA Code of Professional Conduct?
Integrity
Objectivity
No Conflicts of Interest
No known misrepresentations of facts
No outsourcing of judgment
228
What are threats and safeguards to independence?
Safeguards > Threats - Independence
Threats > Safeguards - No Independence
229
What are the threats to independence?
Self-Review (Auditing own work)
Advocate of the Client
Adverse Interest (Lawsuit against Client)
Too familiar with Client - could impair the appearance of Independence to public
Undue influence on Client - On Board of Directors- exception being an Honorary board position
230
What are the Safeguards to independence?
Offset the threats
Safeguards are created by Legislation (SOX)- Client (Audit Committee)- Accounting Firm (Policies)
231
What are the characteristics of a Covered Member?
On the engagement team- have Significant influence on Audit- such as:
Reviewing Partner
Managing Partner in CPA Firm
Firm Personnel who does more than 10 hours of non-attest work (Income Taxes)
Partner sharing office with another Partner who oversees an engagement
Financial Interest in Client by Covered Member (Auditor on Engagement)
232
What are the requirements for a Covered Member?
No direct financial interest
No Material indirect financial interest
Firm personnel who are not Covered Members cannot own more than 5% of stock
Covered Member's immediate family cannot own more than 5% of stock or be employed in Key positions. If Covered member is aware of this- it will impair independence.
Cannot make management decisions.
All requirements apply during the period of the professional engagement- and as long as they are a client.
233
What happens when a Covered Member disagrees with a Supervisor?
If Supervisor's position is still GAAP/GAAS- defer to Supervisor
If Supervisor's position is not GAAP/GAAS- report to higher levels of management
If management ignores you- consider leaving the firm
234
When is independence required?
Audit
Review
Attestation Engagement
235
What are the requirements for nonattest engagements?
Everything must be documented in writing
Client must still perform all management functions
_Client must assign someone of competence to oversee the nonattest engagement and CPA must be satisfied that this has occurred
Engagement must have definite objectives
Engagement limitations disclosed
Understanding must be reached and documented before any nonattest work can begin
If CPA performs more than one nonattest function, they must be evaluated as a whole to see if Independence is impaired
236
Which standards apply to consulting engagements?
Consulting engagements are covered by Statements on Standards for Consulting Services (SSCS)
Requirements: Competence- Due Care- Planning- Supervision- Obtain Sufficient Data- Must Serve Client Interest- Must have written or oral agreement- must communicate with client.
237
List some common consulting engagements.
Advisory Services
Transaction Services
Management Consulting
Implementation Services
238
What is the rule concerning contingent fees for a covered member?
Not allowed if Member also performs services where independence is required
Commissions or referral fees for Covered Members are not allowed
Example - Audit firm gets a commission for recommending to Client that they implement a new A/P System...NOT Allowed
If a firm performing non-attest work doesn't also perform Covered Member services (aka - Independence not
required)- then Firm can get a commission on referring products/services- but they must disclose to the Client
Tax Preparation - Payment according to refund amount is disallowed
239
When are contingent fees allowed?
When fees are structured relative to judicial proceedings.
Example: IRS audit- or filing an amended tax return subject to tax case with a different taxpayer.
240
How should recommendations and suggestions by a covered member to a client be handled?
Client must carry them out - covered member cannot perform management functions.
Client must assign someone of competence to oversee the non-attest engagement and CPA must be satisfied that this has occurred.
241
What are the requirements for Personal Financial Planning Engagements?
Must have definite objectives
Must have specific procedures planned
Must have a basis for recommendations
Must have recommendations communicated
Must have action steps to implement
242
When is a GAAP departure appropriate?
Departure from GAAP is appropriate if GAAP would cause Financial Statements to be misleading- then it must be explained/disclosed.
243
When may a covered member disclose confidential information?
Member may disclose confidential info when client isn't following GAAP
OR
If they receive a subpoena - CPAs are not Attorneys- so there is no CPA-Client privilege
244
What is the effect of not returning all client-provided documents upon request?
This is an act discreditable.
You MUST return all documents the client gives you even if they don't pay their bill.
If you create a document- however- like a work paper- you are not required to give the client a copy of papers you created if they haven't paid their bill
They are the firm's work papers- but are still confidential!
245
What are the rules with respect to CPA firm names?
CPA firm names must not be misleading.
If partner dies- remaining partner has two years to change name if partnership dissolved. If partner dies and more than one partner still remains (i.e. 1 dies and you still have 2 or more partners...you don't need to change the name)
All Partners/Shareholders must be members of the AICPA in order to hold themselves out as members of the AICPA. Non-CPAs can be owners- but 2/3 of Ownership must be CPAs. Non-CPA owner must not be involved with the accounting- and is still bound by AICPA code of conduct- must maintain CPE requirements and have Bachelor's degree.
246
What is the consequence of disclosing CPA exam material post-1996?
It is an Act Discreditable.
247
What are the consequences for a CPA who commits an Act Discreditable?
Licenses are granted at the State level
If State revokes certificate- AICPA Ban
Felony Conviction- AICPA Ban
Prepares Fraudulent Tax Return- AICPA Ban
Intentionally failing to file return- AICPA Ban
SEC can get involved with discipline
248
What are the functions of the PCAOB?
Monitors CPA Firms who audit SEC clients - All SEC Audit firms must register
Issues standards for firms to follow - usually stricter than AICPA standards
249
When is independence impaired under PCAOB standards?
If Client pays a contingent fee (i.e. based on outcome)
With Marketing or Planning engagements
Aggressive Tax Strategies
Firm does tax work for Client employee involved with audit oversight or their
family
250
Who must approve non-audit work performed by a firm for a client?
Client Audit Committee must approve non-audit work performed by Firm
Firm must disclose any potential independence issues to Audit Committee
251
Which organization is in charge of determining if federal funds are being misappropriated?
GAO - Government Accountability Office
252
What rules must auditors follow for governmental audits?
Auditors must follow both GAAS and GAS aka the Yellow Book materiality threshold is usually lower
More detail is required on working papers
More stringent CPE rules and requirements - 24 hours of continuing education must be related to governmental auditing every 2 years
Compliance with Regulations is a requirement of the Audit Report
