Audit II final Flashcards
Accounting estimate
“An approximation of a financial statement element, item or account.”
Management’s point estimate
Amount selected by management and recorded in the financial statements
Reasons to include estimates
Measurement or valuation of an account is uncertain Relevant data concerning the events cannot be accumulated Estimates are included in several accounts in the FS
Analytical procedures
Evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data
Preliminary analytical procedures
Used to help the auditor identify risks and plan the nature, timing and extent of audit procedures. Comparing historical numbers to current numbers Required, ratio analysis
Substantive analytical procedures
Used to obtain evidence about specific assertions related to account balances or transactions
Final Analytical procedures
Used as an overall review for the financial statement audit. Required, corroborating evidence required
Types of analytical procedures
trend analysis- across time periods ratio analysis- relative size reasonableness test- not unusual
Short term liquidity ratios
Current ratio Quick ratio Operating cash flow ratio
Activity ratios
Receivables turnover Days outstanding in A/R Inventory turnover Days of inventory on hand
Profitability ratios
Gross profit percentage Profit margin Return on assets Return on equity
Assurance filling the bucket hierarchy
- Risk assessment procedures 2. Tests of controls 3. Substantive analytical procedures 4. Remaining assurance needed from tests of details
Tolerable difference depends on _____
the significance of the account; the desired degree of reliance on the substantive analytical procedures; the level of disaggregation in the amount being tested; and the precision of the expectation. Always less than planning materiality
Data reliability criteria
From an independent source Level of aggregation Effectiveness of controls Tested in a prior year
Auditor’s point estimate
Amount or range of amounts, derived from audit evidence for use in evaluating recorded amounts
Estimation uncertainty
Susceptibility of an accounting estimate to lack of precision in measurement
Outcome of auditing estimate
The actual monetary amount that results from resolution of events/conditions that caused an estimate to be recorded.
Financial statement estimate accounts
NRV of receivables/inventory Valuation of long-lived/intangible assets Revenue recognition Pension/warranty reserves, accruals
In regards to estimates, Auditors must obtain reasonable assurance that _____
All accounting estimates that could be material to the F/S have been developed Accounting estimates are reasonable in the circumstances Accounting estimates are presented in conformity with applicable accounting principles – and properly disclosed
3 ways auditors test for reasonableness
Review and test the process used by management to develop the estimate Develop an independent expectation of the estimate to corroborate the reasonableness of management’s estimate Review subsequent events or transactions occurring prior to the date of the auditors report
Steps to test the process of developing an estimate
Identify relevant controls over preparation Evaluate reliability, relevance and sufficiency of data \ Consider any other key factors and assumptions Consider consistency with industry and historical data. Review documentation of assumptions used Consider specialist Test management calculations
Sources that provide evidence about estimates
Board minutes (changes in uses of long lived assets) Changes in the way mgmt. accumulates and uses information Inquiries from lawyers / legal counsel Regulatory correspondence (FDA for Inquires of management
Factors to consider when auditing estimates
Factors and assumptions that are significant to the accounting estimate Sensitivity to variation Deviations from historical patterns Subjectivity and susceptibility to misstatement and bias How good has management been at developing estimates in the past
Areas with fair value measurements
Investment securities Derivatives Mergers and acquisitions (assets and liabilities) Financial liabilities Asset impairment tests (i.e. goodwill, intangibles, PPE) Pensions
Fair Value (definition)
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement (balance sheet) date
Market approach
Uses prices and other relevant information generated by market transactions for identical or comparable assets/liabilities Level 1 or 2
Income approach
Converts future values (cash flows) into a single current value Level 2 or 3 (More likely level 3)
Cost approach
Fair value is based upon what it would cost to build an identical asset or replace the service capacity of an asset, adjusted for obsolescence Level 2 or 3
Valuation inputs
Assumptions that market participants would use in valuing the asset or liability, including assumptions about risk
Observable inputs
Assumptions market participants would use in pricing the asset or liability based on market data obtained from independent sources
Un-observable inputs
Company’s own assumptions about assumptions market participants would make to value an asset
Levels 1,2,3
Level 1- quoted market prices in active markets for identical assets Level 2- quoted market price either in inactive markets or similar assets Level 3- Unobservable imputs, management assumptions. Ex. projected growth rate
Process to audit FV measurements
Risk assessment - inherent risk, control risk and risk of material misstatement for FV measures Understand management’s process and controls over fair value measurements Perform substantive procedures Reporting – ensure proper disclosure of FV measures
Ways to test FV measurements
Test management’s process Develop their own independent fair value estimate Review subsequent events and transactions
Ways to evaluate a model with no observable inputs
Management has sufficiently evaluated and applied accounting standards Valuation method is appropriate for circumstances, business, industry and environment in which it operates
Precision (definition)
How good of expectation can you develop How good is the analytical procedure at developing an expectation How well did you plan, design, and execute the analytical test
Revenue recognition criteria
Evidence of arraignment Evidence that goods/services have been delivered Price is fixed or determinable Ability to collect payment is reasonably assured.
ASC 606 Steps to recognize revenue
Identify the contract Determine the performance obligations Determine the transaction price Allocate the transaction price Recognize revenue
Rules for recognizing revenue when customers have a right to return
Consignment- Sale is not contingent on buyer reselling Buyer’s obligation to pay does not change in instance of theft Buyer is economically separate from seller Seller does not have significant obligations for future performance Future sales returns can be reasonably estimated
Premature revenue recognition methods
Channel stuffing- sending customers products who have not yet agreed to purchase them. Most common Shipping unfinished products to customers Test- Look for unusually high sales returns right after the year end.
Ways to detect/prevent premature revenue recognition
Look for unusually high sales returns right after the year end. Check that shipping personnel are arranging shipments, not sales personnel Check that accounting personnel require a copy of customer order form
Ways to test for fictitious sales
Positive/negative confirmation request. Negative only works if the customer exists and the balance is wrong Collections from customers after year-end. If the sale is fictitious no collection can be made Higher risk if sales are from one major source
Round tripping
Two parties record transactions with each other but there is no economic benefit. Ex. 2 companies sell inventory to each other and record revenue
Ways to test for round tripping
Review significant transactions involving counterparties in the same line of business or related parties Look for identical vendors and customers Review transactions with a counter party that is being acquired Look where the products are being shipped (not to someones house)
Percentage of completion method
Used in revenues with service, revenue recorded based on the percentage of completion Often companies over state how much of product has been completed
Ways to test that % of completion revenue has not been overstated
Review sales agreement for timing of payments and estimated completion date Make sure “Upfront fees” are not recorded, they should be recognized over life of service provided Examine the product to see how much has been completed
Sales contracts with multiple elements
If a contract requires the seller to provide “multiple deliverables” such as shipping and installation, the sale is not complete until substantially all elements are delivered
Ways to test revenue for sales contracts with multiple elements
Confirm with customers which elements of the contract have been completed Assess whether substantially all elements have been completed
Ways to test for fictitious receivables
Look for unexpected increase in days sales outstanding or in proportion of credit sales Test for excessive write-offs of receivables after the year-end Aging analysis Receivables from related parties
Audit procedures to test for fictitious inventory
Attend year-end inventory count Inspect inventory for existence as of year-end, open boxes, make sure it exists Test for manual journal entries to the inventory accounts
Going concern assumption
Assumption that the client will remain a GC for the “foreseeable future” - 1 year from date of the financial statements
Steps to evaluate substantial doubt of going concern
Evaluate management’s plans to overcome the events/conditions causing substantial doubt Examine the assumptions in the plans (most important) Project future conditions and events for 1 year following date of financial report If there is still substantial doubt, include an explanatory paragraph in audit opinion
Indicators of substantial doubt about Going Concerns
Operating- lack of strategy, loss of management/customers, strikes, cash flow problems Financial- can’t meet loan covenants (biggest indicator), high leverage, lack of profits, dividend cuts, disposal of assets External- successful competitor, litigation, obsolete products, new regulations
Audit procedures to evaluate going concern assumption
Verify compliance with loan covenants Assess management plans to improve performance Identify post balance sheet date events Review A/P (can they pay) and recent accounts Written confirmation from related parties about willingness to provide financial support
Management was required to evaluate going concern assumptions effective ________
December 15, 2016 Applies to periods ending after
2 types of Illegal Acts
Direct and Material- directly affects financial statements Ex. tax laws Indirect and Material- Ex. violation of safety laws. Only investigate if brought to attention.
Indicators of Illegal Acts
Unauthorized/improperly recorded transactions Unusual fines, government investigation Excessive sales commissions Large cash payments Payments to government officials Not filing taxes
Ways auditors discovers illegal acts
Routine audit procedures Review of board meeting minutes / special committee minutes Communications with legal counsel Reviews of litigation, claims and assessments Explicit inquiries of management
Circumstances where auditor must disclose an illegal act to a 3rd party
Change in auditor (Form 8-K) When successor auditor makes inquiries In response to a subpoena Funding agency for entities that receive funding from a governmental agency
Who is required to comply with FCPA?
US listed companies Foreign companies listed in US Third parties (Ex. brokers) acting on behalf of a listed corporation
Required items for audit completion
Contingent Liabilities Legal letters Disclosure of Commitments Review Subsequent Events Evaluate audit results, going concern assumption Communicate with management/audit committee
Contingent liability
An existing condition, situation, or set of circumstances with uncertainty as to possible loss to an entity that will be resolved when some future event occurs or fails to occur
Categories of contingent liabilities
Probable- Accrue if estimable, otherwise disclose Possible- Disclose in footnotes Remote- No disclosure
Documents to review for contingent liabilities management failed to disclose
Board meeting minutes contracts leases loans correspondence from gov’t agencies tax returns IRS reports income tax liability schedules
Requirements for sending a request for legal letter
Specify a materiality amount Materiality amount must be much lower than financial statement materiality
Subsequent events
Events that occur after the balance sheet date but before the audit opinion are issued
Type 1 and Type 2 subsequent events
Type 1- Uncollectible account, lawsuit settlement Type 2- M&A, disposal of business, Issuance of stock or debt, fire/flood
Audit Procedures to look for Subsequent events
Inquire of management Inquire of legal counsel Read Minutes of Meetings Read interim financial statements
Liquidation basis
Basis for financial statements when business is not a GC Used when the Going concern values of assets > liquidation values Mark assets and liabilities to fair value
Management obligation on going concern assumption
Management must disclose conditions and events that raise doubt if substantial doubt exists
Critical audit matters
A matter that was communicated, or required to be communicated to the audit committee that is both material and subjective/complex
Lack of auditor independence results in a ________
Disclaimer of opinion
Auditor’s responsibility for areas outside the FS
Read all of the paragraphs and make sure they are not inconsistent with FS and footnotes If inconsistent, require a change or take action if mgmt doesn’t make change
