Audit Lecture 1

Question 1

State the primary purpose of an audit.

Answer 1

To provide financial statement users with an opinion on whether the financial statements are fairly presented, in all material aspects, in accordance with the applicable financial reporting framework.

Question 2

Identify three inherent limitations of an audit

Answer 2

• The nature of financial reporting
• The nature of audit procedures
• Timeliness of financial reporting and the balance between benefit and cost

Question 3

Which standards provide the most authoritative U.S. auditing guidance for nonissuers and issuers, and who issues those standards?

Answer 3

Nonissuers:

Statements on Auditing Standards (SASs), issued by the AICPA Auditing Standards Board.

Issuers:

Auditing Standards (ASs), issued by the Public Company Accounting Oversight Board (PCAOB) plus all SAS Adopted by the PCAOB.

Question 4

Describe the role of the International Auditing and Assurance Standards Board (IAASB) and the use of International Standards of Auditing (ISAs).

Answer 4

IAASB is a standard-setting board of the International Federation of Accountants (IFAC) that establishes ISAs.

Currently, over 100 countries are using or are in the process of adopting ISAs.

ISAs do not override local laws/regulations or national standards that govern the audits of financial statemetns in a given country.

Question 5

What are the five general GAAS requirements related to the conduct of an audit?

Answer 5

S - Professional Skepticism

E - Ethical Requirements

J - Professional Judgment

E - Sufficient and Appropriate Audit Evidence

C - Compliance with GAAS

Question 6

List in order the primary sections of an unmodified audit opinion.

Answer 6

Title: Independent Auditor’s Report

Addressee: Based on the circumstances of the engagement

Introduction: We have audited the accompanying financial statements of . . .

Management’s Responsibility for the Financial Statements: Management is responsible for the preparation and fair presentation of the financial statements . . .

Auditor’s Responsibility: Our responsibility is to express an opinion on these financial statements based on our audit.

Opinion: In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position . . .

Report on Other Legal and Regulatory Requirements: If applicable

Question 7

What should be included in the introductory paragraph of the unmodified audit opinion?

Answer 7

The introductory paragraph should include:

• The entity whose financial statements have been audited
• A statement that the financial statements were audited
• The title of each financial statement audited
• Dates or periods covered by each financial statement

Question 8

What should be included in the Management’s Responsibility paragraph of the unmodified audit opinion?

Answer 8

• An explanation that management is responsible for the preparation and fair presentation of the financial statements
• A statement that this responsibility includes the design, implementation, and maintenance of internal control

Question 9

What should be included in the Auditor’s Responsibility paragraph of the unmodified audit opinion?

Answer 9

• A statement that it is the auditor’s responsibility to express an opinion on the financial statements based on the audit
• A statement that the audit was conducted in accordance with auditing standards generally accepted in the United States of America
• A statement that standards require that the auditor plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement
• A description of the audit

Question 10

What should be included in the opinion paragraph of the unmodified audit opinion?

Answer 10

1. A statement that the financial statements present fairly, in all material respects, the financial position of the entity as of the balance sheet date and the results of operations and its cash flows for the period then ended, in accordance with the applicable financial framework.
2. Identification of the applicable financial reporting framework and its origin.

Question 11

Where in the standard unmodified opinion does the auditor refer to (1) the applicable financial reporting framework (i.e., GAAP or IFRS) and (2) generally accepted auditing standards?

Answer 11

1. The applicable financial reporting framework is referred to in the management’s responsibility paragraph and opinion paragraph.
2. GAAS is referred to in the auditor’s responsibility paragraph.

Question 12

Identify the key differences in the auditor’s report under U.S. GAAS and the ISAs.

Answer 12

Requirements in Auditor’s Report under ISAs (not GAAS)

• The introdutory paragraph refers to the summary of significant accounting policies and other explanatory information.
• The report may refer to “the presentation and fair presentation of the financial statements” (consistent with GAAS) or “the preparation of financial statement that give a true and fair view” (not allowed under GAAS).
• The auditor’s responsibility paragraph must include a statement that the auditing standards require that the auditor comply with ethical requirements.

Requirements in Auditor’s Report under GAAS (not ISAs)

• Sufficient appropriate audit evidence should include evidence that the audit documentaion has been reviewed.
• The description of management responsibilities for the financial statements in the auditor’s report should not be referenced to a separate statement by management if such a statement is included in a document containing the auditor’s report.

Question 13

Define a component auditor.

Answer 13

A component auditor is an auditor who performs work on the financial information of a component that will be used as audit evidence for the group audit. The component auditor may be part of the group engagement partner’s firm, a network firm, or another firm.

Question 14

Identify the two requirements that are necessary to reference a component auditor in the auditor’s report.

Answer 14

Reference to the component auditor in the auditor’s report can be made if the following requirements are met:

• The component auditor as performed an audit in accordance with GAAS, or when required, the PCAOB.
• The component auditor’s report is not restricted use.

Question 15

What are the responsibilities of a group engagement partner (team) when it assumes responsibilty for the work of a component auditor?

Answer 15

No reference to the component auditor is made in the auditor’s report.

If the component is a significant component due to its individual financial significance, it should be audited by the group engagement team or the component auditor.

When a component is deemed significant because of significant risks of material misstatement to the group financial statements, the group engagement team or component auditor should perform additional audit procedures pertaining to the potential risks identified.

Components that are not considered significant only require that analytical procedures be performed by the group engagement team.

Question 16

When should an auditor’s opinion be modified?

Answer 16

A modification to the auditor’s report is necessary when:

• the auditor determines that the financial statements as a whole are material misstated (GAAP issue); or
• the auditor is unable to obtain sufficient appropriate audit evidence to conclude that the financial statements as a whole are free from material misstatement (GAAS issue).

Question 17

What is the purpose of an emphasis-of-matter paragraph?

Answer 17

The purpose of an emphasis-of-matter paragraph is to reference a matter that is appropriately presented in the financial statements, but is of such importance that it is fundamental to the user’s understanding of the financial statements.

Question 18

What are the reporting requirements for an emphasis-of-matter paragraph?

Answer 18

Reporting requirements for an emphasis-of-matter paragraph include:

• Placing the paragraph immediately after the opinion paragraph.
• Using the heading “emphasis-of-matter” or another appropriate heading.
• Describing the matter being emphasized and the location of relevant disclosures in the financial statements.
• Indicating that the auditor’s opinion is not modified with respect to the matter emphasized.

Question 19

Under what circumstances would an emphasis-of-matter paragraph be required in an auditor’s report?

Answer 19

An emphasis of matter paragraph should be used in the auditor’s report when:

• the auditor determines there is substantial doubt regarding the entity’s ability to continue as a going-concern for a reasonable time period;
• there is a need to describe a justified change in accounting principle that has a material effect on the entity’s financial statements;
• facts are subsequently discovered that lead to a change in the auditor’s opinion (note: an other-matter paragraph may also be appropriate); or
• the financial statements are prepared in accordance with an applicable special purpose framwork, other than regulatory basis financial statements intended for general use.

Question 20

What are the reporting requirements for an other-matter paragraph?

Answer 20

Reporting requirements for an other matter paragraph include:

• Placing the paragraph immediately after the opinion paragraph and after any emphasis-of-matter paragraph.
• Using the heading “other-matter” or another appropriate heading.
• Describing the matter being emphasized and the location of relevant disclosures, if applicable, in the financial statements.

Question 21

Under what circumstances would an auditor use an other-matter paragraph in an auditor’s report?

Answer 21

Use of an other-matter paragraph is required in the auditor’s report if:

• the auditor includes an alert in the audit report that restricts its use;
• facts are sebsequently discovered that lead to a change in the auditor’s opinion (note: an emphasis-of-matter paragraph may also be appropriate);
• prior period financial statements were audited by a predecessor auditor and the precedessor’s audit report is not reissued;
• current period financial statements are audited and presented in comparative form with compiled or reviewed financial statements for the prior period;
• The auditor chooses (or is required) to report on supplementary information presented iwth financial statements in the auditor’s report;
• special purpose financial statements are prepared in accordance with a contractual/regulatory basis of accounting (requiring a restriction on the use of the auditor’s report); or
• the auditor’s report on the financial statements includes a compliance report.

Question 22

Evidence from what auditing procedures may lead the auditor to conclude that there is a signification doubt about an entity’s ability to continue as a going concern?

[ADMITS!]

Answer 22

Evidence obtained from the following procedures may reveal going concern issues:

• *A**nalytical procedures
• *D**ebt compliance
• *M**inutes
• *I**nquiry of client’s legal counsel
• *T**hird parties
• *S**ubsequent event review

Question 23

What conditions and events may indicate substantial doubt about an entity’s ability to continue as a going concern?

[FINE]

Answer 23

The following conditions and events may be indicatibe of substantial doubt:

• Financial difficulties
• Internal matters, such as labor difficulties, substantial dependence on a particular project, etc.
• Negative trends
• External matters, such as legal proceedings, new legislation, loss of a principal customer, natural disasters, etc.

Question 24

According to U.S. Auditing Standards, what phrases must be included in a going concern emphasis-of-matter paragraph?

Answer 24

“Substantial doubt”

and

“Going concern”

Question 25

What is the going concern period for (1) U.S. GAAP and (2) ISA?

Answer 25

1. The going concern period should not exceed one year under U.S. auditing standards.
2. The going concern period may be greater than or equal to one year under ISAs.

Question 26

When there is a year-to-year lack of comparability (consistency) in an entity’s financial statements due to an acceptable change in accounting principle, how does that auditor reflect this in the current year’s auditor’s report?

Answer 26

What the auditor concludes that the change in accounting principle is acceptable (justified), the auditor should include an emphasis-of-matter paragraph in the auditor’s report describing the change in accounting principle and provide a reference to the entity’s disclosure of the change.

If the justified change in accounting principle is deemed immaterial, no revision to the report is necessary.

Question 27

How is an alert that restricts the use of the auditor’s written communication reflected in the auditor’s report and what items should be included in the alert?

Answer 27

An other-matter paragraph is used to restrict the use of the auditor’s report when required by GAAS or when the auditor deems it necessary.

The alert that resticts the use of the auditor’s written commincation includes:

• a statement that the auditor’s written communciation is intended solesly for the information and use of the specificed parties;
• identification of the specified parites for whom use is intended; and
• a statement that the auditor’s written communication is not intended to be and should not be used by anyone other than the specified pari

Question 28

When would an auditor use professional judgment to determine whether to issue a qualified opinion or adverse opinion?

Answer 28

When audit evidence indicates that there is material misstatements of the financial statements.

A qualified opinion is issued when the auditor concludes that misstatements, individually or in aggregare, are material but not pervasive to the financial statements.

An adverse opinion is issed when the auditor concludes that misstatements, individually or in the aggregate, are both material and pervasive to the financial statements.

Question 29

Describe the circumstances in which a material misstatement of the financial statements may arise.

Answer 29

Misstatements may arise in relation to:

• The appropriateness of accounting policies
• The application of accounting policies
• The appropriateness of the financial statement presentation
• The appropriateness or adequacy of disclosues in the financial statements

Question 30

When would an auditor use professional judgment to determine whether to issue a qualified opinion or a disclaimer opinion?

Answer 30

When there is a limitation on the scope of the audit.

A qualified opinion is issued when an auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion and the auditor determines that the possible effects could be material but not pervasive.

A disclaimer of opinion is expressed when the auditor is unable to obtain sufficient appropriate audit evidence on which to base an opinion and the auditor determins that the possible effects could be both material and pervasive.

Question 31

If an opinion is modified, where does the paragraph explaining the modification appear?

Answer 31

The paragraph explaining the modification would appear prior to the opinion paragraph. The “basis for modification” paragraph should use the appropriate heading. Appropriate headings include:

• Basis for Qualified Opinion
• Basis for Adverse Opinion
• Basis for Disclaimer of Opinion

Question 32

Identify some causes for scope limitations.

Answer 32

Restrictions on the auditor’s ability to perform auditing procedures may be caused by:

• Circumstances
• Management
• Inability to observe inventory
• Inability to confirm receivables
• Refusal of the client’s attorney to respond to inquiry
• Refusal of management to provide a representation letter

Question 33

The auditor’s report should not be dated earlier than the date on which the auditor obtained sufficient appropriate audit evidence. This should include evidence that what three things have occurred?

Answer 33

Evidence that:

1. audit documentation has been reviewed;
2. financial statements have been prepared; and
3. management has taken responsibility for the financial statements.

Question 34

What situations may result in a disclaimer of opinion?

Answer 34

• Pervasive inability to obtain sufficient appropriate audit evidence.
• Lack of independence (always results in a disclaimer).
• Going concern uncertainty (Note: If adequate disclosure of going concern exists, the auditor may choose between an unmodified opinion when an emphasis-pf-matter paragraph or a disclaimer of opinion)

Question 35

Compared to a standard unmodified opinion, determine the paragraphs that are modified in an audit report when the following opinions are issued:

• Qualified
• Adverse
• Diclaimer

Answer 35

• Qualified Opinion
  
  • Standard Intro
  • Standard Management Responsibility
  • AR: Name type of modified opinon
  • Add Basis for Opinion Paragraph
  • Opinion: Except for
• Adverse Opinion
  
  • Standard Intro
  • Standard Management Responsibility
  • AR: Name type of modified opinion
  • Add Basis for Opinion Paragraph
  • Opinion: Do not present fairly
• Disclaimer of Opinion
  
  • Intro: Engaged to audit
  • Standard Management Ressponsibility
  • AR: Not able to obtain…
  • Add Basis for Opinion
  • Opinion: Disclaimer

Question 36

How do uncertainties affect the auditor’s report?

Answer 36

Uncertainty and Opinion

• Management’s analysis of uncertainty is supported and properly reported and disclosed.
  
  • Unmodified opinion with no reference to uncertainty (Note: The auditor may add an emphasis-of-matter paragraph id the auditor determines that further explanation is necessary.)
• Unable to ontain sufficient evidence involving uncertainty
  
  • Qualified Opinion or Disclaim an Opinion
• Financial statemants are materially misstated due to departure from GAAP
  
  • Qualified Opinion or Adverse Opinion

Question 37

According to U.S. GAAP, when are contingencies (such as pending litigation) required to be:

• accrued and disclosed?
• disclosed only?

Answer 37

• Probably
  
  • Can Estimate Loss Amount: Accrue and disclose
  • Cannot Estimate Loss Amount: Disclose
• Reasonably possible
  
  • Disclose for both can and cannot
• Remote
  
  • May ignore. (Should disclose if a “guarantee type” contingency

Question 38

If, during the current examination of comparative financial statements, the auditor discovers evidence that affects the prior period statements and the opinion that was expressed, what action should be taken?

[Only DORCS change their mind!]

Answer 38

The auditor should update the opinion in the current year’s report. If the opinion differs from the previous opinion, the reason(s) should be disclosed in a separate emphasis-of-matter paragraph or other-matter paragraph following the opinion paragraph.

The explanatory paragraph should disclose the:

• Date of the auditor’s previous report
• Opinion type previously issued
• Reasons for prior opinion
• Changes that have occurred
• Statement “opinion . . . is different.”

Question 39

The predecessor auditor should take what steps before reissuing an audit report on prior period financial statements?

Answer 39

• Read the financial statements for the current period.
• Compare the previous audited statements with the current period statements.
• Obtain a letter of representation from the sucessor auditor.
• Obtain a letter of representation from management at or near the date of reissuance.
• If unrevised, use the original report date; if revised, dual date the report.

Question 40

What statements should be included in the auditor’s report in an other-matter paragraph when comparative financial statements are presented and the prior auditor’s report is not reissued?

Answer 40

The other-matter paragraph should include the following:

1. A statement that the financial statements of the prior period were audited by the predecessor auditor.
2. The type of opinion expressed by the predecessor auditor. If the opinion was modified, include the reasons for the modification.
3. The nature of any emphasis-of-matter or other-matter paragraph included in the predecessor’s report.
4. The date of the predecessor auditor’s report.

Question 41

What is the effect on the audit report when the current period financial statements are audited and presented in comparative format with prior period financial statements that were not audited?

Answer 41

If the prior period financial statements were reviewed or complied, an other-matter paragraph is added that includes:

Question 42

Define two types of subsequent events.

Answer 42

A recognized subsequent event relates to a condition that existed on or before the balance sheet date. Recognized subsequent events require financial statement adjustment.

A nonrecognized subsequent event occurs after the balance sheet date. Nonrecognized subsequent events generally do not require financial statement adjustment, but may require footnote disclosure.

Question 43

What procedures should the auditor perform during the subsequent period?

Answer 43

Between the date of financial statements and the date of the auditor’s report (subsequent period), the auditor should: [PRIME]

• Review post balance sheet transactions.
• Obtain a represenation letter from management describing the events that occurred during the subsequent period requiring adjustment to the financial statements.
• Inquire with management or those charges with governance whether subsequent events occurred that could impact financial statements.
• Review minutes of board and committee meetings.
• Examine current interim financial statements and compare to financial statements under audit.

Question 44

After the date of the auditor’s report, what actions should an auditor take regarding subsequent events?

Answer 44

None. Although the auditor is responsible for investigating subsequent events until the date of the auditor’s report, the auditor has no active responsibility to make inquiries or perform auditing procedures after that date.

Question 45

When and why is dual dating used?`

Answer 45

Dual dating is used when subsequent events requiring financial statement adjustment or disclosure come to the auditor’s attention after the original date of the audit report. Dual dating extends the auditor’s responsibility only for a particular subsequent event. The original date of the report is retained for the rest of the financial statements.

Question 46

After issuance of the report, what actions should an auditor take upon discovering information that materially affects the report?

Answer 46

Determine whether there are persons relying or likely to rely on the financial statements.

Advise the client to immediately disclose the new information to persons currently relying or likely to rely on the financial statements. This disclosure may take the form of revised financial statements, disclosures and revisions to any imminent financial statements, or notification that the financial statements and report should not be relied upon.

Advise the client to discuss the new disclosures or revisions with the SEC, stock exchanges, and appropriate regulatory agencies.

Ensure that appropriate steps are taken by the client.

Question 47

What actions should an auditor take upon discovering omitted auditing procedures?

Answer 47

The auditor should:

1. Determine whether other procedures were adequate to compensate for the omitted procedures.
2. If not, and if there are people likely to be relying on the report, apply the omitted (or alternative) procedures.
3. If facts emerge that support a different opinion, advise the client to make the appropriate disclosure and notification.

Question 48

What is the auditor’s responsibility with respect to information accompanying the basic financial statements in a client-prepared document?

Answer 48

The auditor should read the other information to determine that it is consistent with the audited financial statements and that there are no material inconsistencies or material misstatements of fact.

The auditor may (but is not required to) report on the other information.

Question 49

What are the two objectives of engagements to report on supplementary information?

Answer 49

1. To evaluate the presentation of the supplementary information in relation to the financial statements as a whole.
2. To report on whether the supplementary information is fairly stated, in all material respects, in relation to the financial statements as a whole.

Question 50

What procedures would an auditor perform related to supplementary information that accompanies the financial statements and is required by a designated accounting standard setter, such as the FASB?

Answer 50

Apply limited procedures, which includes:

• Inquiry regarding how the supplementary information was prepared, including changes from prior years and significant assumptions used.
• Determining whether the methods used are consistent with management’s responses, auditing financial statements, and other knowledge.
• Obtaining written management representations regarding the required supplemental information.
• The auditor may (but is not required to) issue an opinionon the information.

Question 51

List several features of a report on the application of the requirements of an applicable financial reporting framework.

Answer 51

• Description of engagement, entity, and transaction
• Reference to the AICPA standards
• Description of the appropriate application of the requirements of the applicable financial reporting framework to the specific transaction or type of report
• Preparers are responsible for proper accounting
• Differences in facts, circumstances, or assumptions may change the report
• Restricted used paragraph

Question 52

When accepting an engagement to audit financial statements prepared in accordance with a financial reporting framework generally accepted in another country, the auditor should obtain an understanding of:

Answer 52

• The purpose for which the financial statements are prepared
• Whther the financial reporting framework is a fair presentation framework
• The intended users of the financial statements
• The steps taken by management to ensure that the applicable financial reporting framework is acceptable under the circumstances
• The legal responsibilities involved (if using the form and content of another country’s audit report).

Question 53

What are the reporting options for financial statements prepared in accordance with a financial reporting framework generally accepted in another country when the financial statements will be distributed outside the U.S. only? What if the financial statements are also intended for use intended for use within the U.S.?

Answer 53

Distributed Outside the U.S. Only

• Report form of the other country or the report sent out in the ISAs (if applicable); or
• U.S. style report modified to refer to the financial reporting framework generally accepted in another country.

Distributed Within the U.S.

Standard U.S. report with an emphasis-of-matter paragraph that:

• Identifies the financial reporting framework.
• Refers to the note in the financial statements describing the framework.
• Indicates the framework differs from accounting principles generally accepted in the United States of America.