Audit Lecture 2

Question 1

Which four areas do auditors address in special consideration engagements?

Answer 1

Special consideration engagements include:

• Audits of financial statements prepared in accordance with special purpose framework
• Audits of single financial statements and specific elements, accounts, or items of a financial statement
• Reporting on compliance with aspects of contractual or regulatory requirements associated with audited financials
• Engagements to report on summary financial statements

Question 2

Give examples of special purpose frameworks.

Answer 2

• Cash basis
• Tax basis
• Regulatory basis
• Contractual basis
• Any other basis of accounting that uses a definite set of logical, reasonable criteria that is applied to all material items appearing in the financial statements.

Question 3

Which of the following elements should be included in the auditor’s report when financial statements are prepared on the cash or tax basis?

• Description of purpose for which special purpose financial statements are prepared
• Emphasis-of-matter paragraph alerting readers about the preparation in accordance with a special purpose framework
• Other-matter paragraph restricting the use of the auditor’s report

Answer 3

An emphasis-of-matter paragraph alerting readers about the preparation in accordance with a special purpose framework should be included in the auditor’s report for financial statements prepared on the cash or tax basis.

Question 4

Which of the following elements should be included in the auditor’s report when financial statements are prepared on the regulatory basis (not for general use) and contractual basis?

• Description of purpose for which special purpose financial statements are prepared
• Emphasis-of-matter paragraph alerting readers about the preparation in accordance with a special purpose framework
• Other-matter paragraph restricting the use of the auditor’s report

Answer 4

An auditor’s report for financial statements prepared on a regulatory basis (not for general use) or contractual basis should include:

• Description of purpose for which special purpose financial statements are prepared
• Emphasis-of-matter paragraph alerting readers about the preparation in accordance with a special purpose framework
• Other-matter paragraph restricting the use of the auditor’s report

Question 5

Which of the following elements should be included in the auditor’s report when financial statements are prepared on the regulatory basis (for general use)?

• Description of purpose for which special purpose financial statements are prepared
• Emphasis-of-matter paragraph alerting readers about the preparation in accordance with a special purpose framework
• Other-matter paragraph restricting the use of the auditor’s report

Answer 5

An audit report for financial statements prepared on the regulatory basis for general use should include the description of purpose for which special purpose financial statements are prepared.

Question 6

What should be included in an emphasis-of-matter paragraph included in a special purpose framework (other than regulatory basis financial statements intended for general use)?

Answer 6

The auditor’s report should include an emphasis-of-matter paragraph that:

1. indicates that the financial statements are prepared in accordance with the applicable special purpose framework.
2. refers to the note to the financial statements that describes that framework.
3. states that the special purpose framework is a basis of accounting other than GAAP.

Question 7

What types of information should an auditor gather prior to auditing a single financial statement or a specific element of a financial statement?

Answer 7

The auditor should obtain an understanding of the:

• purpose for preparing the single financial statement or specific element of a financial statement;
• intended users; and
• steps taken by management to ensure that the applicable financial reporting framework is acceptable under the circumstances.

Question 8

What are some limitations surrounding an auditor’s report on a single financial statement, or a specified element, account, or item of a financial statement?

Answer 8

• If the item is based on stockholder’s equity, the auditor should perform procedures necessary to express an opinion about financial position.
• If the item is based on net income, the auditor should perform procedures necessary to express an opinion about financial position and results of operations.
• If an adverse opinion or disclaimer of opinion was issued, the auditor may not report on items that constitute a major portion of the financial statements. (The auditor may report on nonmajor items, but such reports should not accompany the report on the financial statements.)

Question 9

Under U.S. auditing standards, when may an auditor issue a special report on a client’s compliance with contractual agreements or regulatory requirements?

Answer 9

Under U.S. auditing standards, the auditor:

• must have auditing the client’s financial statements and expressed an unmodified or qualified opinion (i.e., no adverse opinion or disclaimer); and
• may only give negative assurance on the compliance.

Question 10

What type of opinion can an auditor issue on summary financial statements and when is that opinion appropriate?

Answer 10

The auditor may issue either an unmodified opinion or an adverse opinion on the summary financial statements, but cannot issue a qualified opinion due to the summarized nature of the financials.

An unmodified opinion is appropriate when the auditor concludes that the summary financial statements are consistent, in all material aspects, with the corresponding audited financial statements.

An adverse opinion is appropriate when the summary financial statements are not consistent, in all material aspects, with the audited financial statements, and management does not make necessary changes.

Question 11

Name the five elements of compilation and review engagements.

Answer 11

• A three-party relationship (management, the accountant, and the intended users)
• Financial reporting framework
• Financial statements or financial information
• Sufficient, appropriate evidence (review only)
• Written communication or report

Question 12

Compilation and review standards require that an accountant establish an understanding with the client as to the services to be performed. What should be included in this understanding?

Answer 12

An engagement letter is presumptively mandatory and should include:

• A description of the specific compilation or review services to be performed.
• The objectives of the engagement.
• Management’s responsibilities and accountant’s responsibilities.
• An explanation of the limitations of the service, including a statement that:
  
  • the engagement cannot be relied upon to disclose errors, fraud, or illegal acts; and
  • the entity will be informed of any information indicating that fraud or an illegal act may have occured.
• A description of other accounting services, if any, to be performed.

Question 13

Identify the performance requirements that are necessary when engaged in a compilation.

Answer 13

When performing a compilation, the accountant must:

• Possess knowledge of the accounting principles and practices of the client’s industry.
• Have a general understanding of the client’s business.
• Read the compiled financial statements to determine if appropriate in form and free from obvious material errors.
• Follow up with management when aware of fraud or illegal acts, going concern issues, or subsequent events. The accountant should consider the impact of the follow-up on the financial statements, evaluate management conclusions, and consider the effect on the compilation report.

Question 14

How does the expected use of compiled financial statements affect reporting requirements?

Answer 14

• When financial statments are expected to be used by third parties, a compilation report is required.
• When financial statements are not expected to be used by third parties, a written communication (either a compilation report or an engagement letter) is required.

Question 15

What should be included in an accountant’s report on a compilation of a nonissuer’s financial statements?

Answer 15

• Title (“Accountant’s Compilation Report” or “Accountant’s Independent Compilation Report”), addressee, signature and date.
• Introductory Paragraph:
  
  • The entity, financial statements, and dates
  • The financial statements have been compiled
  • The accountant has not audited or reviewed and does not express an opinion.
• Management Responsibility Paragraph:
  
  • Management is responsible for the financial statements and internal contorls
• Accountant Responsibility Paragraph:
  
  • Conducting the engagement in accordance with SSARS
  • Assiting management in presenting financial statements without providing assurance.

Question 16

What are the reporting requirements with respect to compiled financial statements when:

• Substantially all disclosures are omitted?
• Only limited disclosures are included?
• The auditor lacks independence?

Answer 16

Statements that omit substantially all disclosures:

• The accountant can only report if the omission is not intended to mislead expected users.
• The report must clearly indicate the omission.
• The compilation report should be modified by a fourth paragraph disclosing the omissions.

Statements that include only limited disclosures:

• Notes should be labeled “Selected Information–Substantially All DIsclosures Required by GAAP Are Not Included.”

Statements when the accountant lacks independence:

• The last paragraph of the report should disclose the lack of independence. The auditor is permitted, but not required, to disclose the reason(s) for the independence impairment.

Question 17

What are the performance requirements applicable to a review engagement?

[U LIAR CPA]

Answer 17

The performance requirements applicable to a review are:

• *U**–Understanding with client must be established.
• *L**–Learn and/or obtain sufficient knowledge of the entity’s business.
• *I**–Inquires should be addressed to the appropriate individuals.
• *A**–Analytical procedures should be performed.
• *R**–Review–other procedures should be performed.
• *C**–Client representation letter should be obtained from management
• *P**–Professional judgment should be used to evaluate results.
• *A**–Accountant should communication results.

Rememfer the mnemonic “U LIAR CPA.”

Question 18

What should be included in an accountant’s report on a review of a nonissuer’s financial statements?

Answer 18

• Title (Independent Accountant’s Review Report”), addressee, signature, and date.
• Introductory Paragraph:
  
  • The entity, financial statements, and dates
  • The financial statements have been reviewed.
  • A review includes inquiry and analytical procedures.
  • A review is less in scope than an audit and the accountant does not express an opinion.
• Management Responsibility Paragraph:
  
  • Manahement is responsible for the financial statements and internal controls.
• Accountant Responsibility Paragraph:
  
  • Conducting the engagement in accordance with SSARS.
  • Perform procedures to obtain limited assurance
  • Procedures provide a reasonable basis for report.
• Engagement Results Paragraph:
  
  • The accountant is not aware of any material modifications that should be made to the financial statements (other than any indicated in the report).

Question 19

If during the course of an engagement the client requests a change in the engagement (i.e. audit to review), what are some acceptable and unacceptable reasons for the change?

Answer 19

Acceptable reasons for change:

• Change in client requirements
• Misunderstanding as to the nature of services being performed
• Scope limitation but accountant determines change reasonable

Unacceptable reasons for change:

• Current engagement would uncover errors or fraud
• Client is attempting to create misleading or deceptive financial statements
• Scope limitations (client refusing to provide a signed representation letter or not allowing correspondence with client legal counsel)

Question 20

In a review or compilation engagement, an accountant may become aware of a material departure from the applicable financial reporting framework. If the financial statements are not revised, what options does the accountant have?

Answer 20

• Modify the report. If the accountant believes modification of the report is appropriate, a separate paragraph disclosing the departure should be added to the end of the report.

OR

• Withdraw from the engagement. If the accountant believes disclosure in the report would not be adequate to indicate the deficiencies in the financial statements, he or she should withdraw from the engagement.

Question 21

If an accountant has reviewed the prior period financial statements but compiled the current period financial statements, what are his or her reporting options?

Answer 21

The accountant has provided a lower level or service: review to compilation. Reporting options include:

• issuing a compilation report on the current period statements with a paragraph added to describe the responsibility assumed got the prior period statements; or
• reissuing (not updating) the review report on the prior period.

The reissued report may be combined with or presented separately from the compilation report on the current period.

Either the added paragraph (from the first option above) or the reissued report (in the second option) should include the original date and state that no review procedures have been performed since that date,

Question 22

If an accountant has audited prior period statements, but compiled or reviewed current period statements, what are his or her reporting options?

Answer 22

When the level of service decreases from an audit to a review or compilation, the accountant should either reissue the prior period report or include an additional paragraph in the current period report. Such an additional paragraph should indicate:

• that prior period statements were audited;
• the date of the previous report(s);
• the opinions expressed, and if other than unqualified, the reaons for the modification; and
• that no auditing procedures have been performed since the previous report date.

Question 23

What procedures should be performed in a review of the interim financial information of a publicly held company?

[U LIAR CPA]

Answer 23

Auditing standards require the accountant to perform the following:

• *U**–Understanding with client must be established.
• *L**–Learn and/or obtain sufficient knowledge of the entity’s business.
• *I**–Inquires should be addressed to the appropriate individuals.
• *A**–Analytical procedures should be performed.
• *R**–Review–other procedures should be performed.
• *C**–Client representation letter should be obtained from management
• *P**–Professional judgment should be used to evaluate results.
• *A**–Accountant should communication results.

Rememfer the mnemonic “U LIAR CPA.”

Question 24

What should be included in an auditor’s report on the review of interim financial statements of a nonissuer?

Answer 24

• Title ( inclues the word “independent” addressee, signatire, location, date
• Introductory Paragraph:
  
  • The entity, financial statements, and dates
  • The interim financial statements have been reviewed
• Management’s Responsibility Paragraph
  
  • Fair presentation of the interim financial information and internal controls are the responsibility of management
• Auditor’s Responsibility Paragraph
  
  • Conduct the interim financial review in accordance with U.S. GAAS
  • The review of interim financial statements is less in scope than an audit, which expresses an opinion on the financial statements as a whole, whereas an interim financial review expresses no such opinion
• Concluding Section Paragraph (with appropriate heading)
  
  • A statement about whether the auditor is aware of any material modifications that should be made for the interim financial information to be in accordance with the applicable financial reporting framework

Question 25

What type of information should an auditor promptly communicate to management during a review of interim financial information and what action should the auditor take if management fails to appropriately respond?

Answer 25

The auditor should promptly communicate to management if:

• Material modification need to be made to interim financial information to be in accordance with the applicable financial reporting framework.
• The issuer filed quaterly reports (10-Q or 10-QBS) prior to the review being completed.
• The nonissuer issued interim financial information prior to the completion of the review (when the review is required).

When management does not appropriately respond, the auditor should:

• Inform those responsible for corporate governance, and, if they fail to adequately respond, consider resigning or consulting legal counsel.

Question 26

What is a comfort letter and what types of assurance are provided within it?

Answer 26

A comfort letter is a letter from the CPA to underwriters. It provides:

• Positive assurance regarding the CPA’s independence and whether the financial statements comply as to form in all material respects with the applicable requirements of the SEC Act.
• Negative assurance regarding unaudited financial statements, capsule financial information, changes in certain financial statement items, and compliance of certain nonfinancial statement information with SEC requirements.
• A list of procedures and findings (no assurance) regarding pro forma financial information, forecastss, and other financial information.

Question 27

A comfort letter should not comment or provide assurance on what type of information?

Answer 27

The comfort letter (auditor) should not include comments or assurances on:

• Market risk sensitive instruments
• Qualitative disclosures

Question 28

Define an attestation engagement.

Answer 28

An attestation engagement is one in which a practitioner (CPA) is engaged to issue or does issue an examination, a review, or an agreed-upon procedures report on a subject matter, or on an assertion about the subject matter, that is the responsibility of another party (usually management).

Question 29

List six major attestation services.

Answer 29

Reports on:

• Agreed-upon procedures
• Financial forecasts and projectios
• Pro forma financial statements
• Internal control over financial reporting
• Compliance with statutory, regulatory, or contractual requirements
• Management’s Discussion and Analysus (MD&A)

Question 30

What are the five general attestation standards?

[TIPPY]

Answer 30

Training

Independence

Performance (due professional care)

Professional knowledge of subject matter

Your belief that the assertion is capable of evaluation against criteria that are suitable and available to users.

Question 31

What are the two field attestation standards?

Answer 31

• Planning and supervision
• Appropriate, sufficient evidence

Question 32

What are the four reporting attestation standards?

Answer 32

• Identify the Subject matter or the assertion being reported on and the character of the engagement.
• Disclose Significant reservations about the engagement.
• Express conclusions about the subject matter or the assertion in relation to the established or stated criteria.
• Restict the use of the report to specified parties when:
  
  • The criteria are appropriate for or available to only a limited number of parties.
  • Reporting on subject matter and a written assertion has not been provided.
  • Reporting on an agreed-upon procedures engagement.

Question 33

How are attestation standards different from GAAS?

Answer 33

• Attestation standards are broader in scope than GAAS.
• Attestation standards have a different conceptual focus: No reference is made to GAAP or to the financial statements.
• Attestation standards provide a level of assurance below that provided by a GAAS audit.
• Attestation standards provide for services tailored to the needs of the user, who may directly participate in specifying either the nature and scope of the engagement or the criteria which the assertions are measured.

Question 34

What level of assurance may be provided by attestation engagements?

Answer 34

• Examination: A positive opinion, high level or assurance, generally based on a variety of procedures, including search, verification, inquiry and analysis.
• Review (“negative assurance”): Moderate level of assurance, generlly based on inquiry and analytical procedures.
• Agreed-Upon Procedures: No assurance, but procedures and findings are listed.

Question 35

Identify the seven conditions that must exist in order to perform an agreed-upon procedures attestation engagement.

[I AM SURE]

Answer 35

Independence of the practitioner

Agreement of the parties

Measurability and consistency of subject matter

Sufficiency of procedures

Use of report restricted to specified parties

Responsibility of subject matter is with client

Engagements to perform agreed-upon procedures on prosepctive financial statements must include a summary of significant assumptions

Question 36

List some of the key elements in a report on an engagement to apply agreed-upon procedures.

Answer 36

• A title, signature, and date.
• Identification of the specified parties, the subject matter, the character of the engagement, and the responsible party.
• A statement that the subject matter is the responsibility of the responsible party.
• A statement that the procedures were those agreed to by the specified parties.
• A statement that the specified parties (and not the accountant) are responsible for the sufficiency of the procedures.
• A statement that the engagement was conducted in accordance with AICPA attestation standards.
• A list of the procedures performed.
• A statement that the pracitioner did not conduct an examination, a disclaimer of opinion, and a statement that if additional procedures had been performed, other matters might have been reported.
• A statement of restrictions on the use of the report.
• Where applicable, reservations or restrictions concerning procedures or findings.

Question 37

What is the difference between a financial forecast and a financial projection?

Answer 37

A financial forecast reflects, to the best of the responsible party’s knowledge, the expected financial results of a future period based on expected conditions and expected courses of action. A forecast is appropriate for general or limited use.

A financial projection is based on hypothetical assumptions and reflects a “what if” scenario. A projection is appropriate for limited use only.

Question 38

In what three ways might the CPA be associated with prospective financial statements?

Answer 38

The practitioner may:

• Compile prospective financial statements.
• Apply agreed-upon procedures to prospective financial statements.
• Examine prospective financial statements.

Note that a review of prospective financial statements is not allowed.

Question 39

What should be included in the accountant’s report on a compilation of prospective financial statements?

Answer 39

Included in the accountant’s report:

• Identification of prospective financial statements.
• A statement that the practitioner has compiled financial statements in accordance with AICPA attestation standards.
• A statement that a compilation is limited in scope and does not enable the practitioner to express an opinion on any other form of assurance on statements.
• A caveat that the prospective results may not be achieved.
• A statement that the practitioner assumes to responsbility to update the report for events and circumstances occurring after the date of the report.
• The signature of the practitioner’s firm and the date of the report.

Question 40

How does an examination of prospective financial statements differ from the application of agreed-upon procedures?

Answer 40

An examination:

• Is broader and more sibstantial in scope and responsibility than an agreed-upon procedures engagement.
• Includes the expression of an opinion as to whether the statements are presented in conformity with AICPA guidelines and whether the underlying assumptions provide a reasonable basis for the statements.

Question 41

What type of engagement can an accountant perform on pro forma financial statements and what procedures are necessary for a pro forma financial statements engagement?

Answer 41

The accountant can conduct either an examination or review of pro forma financial statements.

The accountant should perform the following procedures in a pro forma financial statement engagement:

• Obtain an understanding of the future or hypothetical event and evaluate the pro forma adjustments and assumptions pertaining to the adjustments.
• Obtain written representations from management.
• Make a reference to the financial statements from which the historical information was derived, and indicate whether the financial statements were audited or reviewed.