Audit Section 3 Flashcards
An example of an entity being expected to accrue a loss contingency for the period under audit is
Legal counsel communicated that an unfavorable judgment from current litigation was reasonably possible. (Example of a recognized subsequent event)
When there is a material loss affects the audit report and there are creditors relying on the financial statements, the client properly should adjust the financial statements. Since they are refusing to do so, the auditor would most likely
notify the board of directors of the situation in an attempt to encourage the adjustment.
When an auditor issues a report that is dual dated for a subsequent event occurring after the original date of the auditor’s report, but before issuance of the related financial statements, the auditor’s responsibility for events occurring subsequent to the original report date is
limited to the specific event referenced.
When facts are discovered after issuing an auditor’s report that would have caused the auditor to revise the report, the auditor should discuss the matter with
management and, if it is determined that the financial statements need revision, ask how management intends to address the matter in the financial statements.
When subsequently discovered information is found both to be reliable and to have existed at the date of the auditor’s report, the auditor should
determine whether there are persons relying or likely to rely on the financial statements who would attach importance to the information.
Long-term debt that matures within one year is reported as a
current liability on the balance sheet. An auditor reviews changes in long-term debt occurring after year-end to evaluate whether such debt is appropriately classified on the balance sheet.
What would an auditor most likely perform in obtaining evidence about subsequent events
Investigate changes in long-term debt occurring after year-end
Since the auditor’s report was newly dated as of April 11, Year 4, the auditor is responsible for subsequent events until that date. The period between the date of the financial statements and the date of the auditor’s report is the subsequent period, during which the auditor is responsible for
investigating certain subsequent events
DUAL DATE is
when a major event comes to the auditor’s attention between the report date and issuance of the report; the financial statements may include the event as an adjustment or disclosure.
An auditor tests accounting records by using
analytical procedures and substantive procedures.
Accounting records consist of records of initial
journal entries and any supporting records.
Internal consistency among a client’s accounting records provides
limited evidence that the financial statements are fairly presented.
A client’s accounting records are
not sufficient support for an audit opinion. The auditor must test the accuracy of the accounting records by performing analytical procedures and substantive procedures.
When confirmations are sent out by the auditor and received back directly, this represents a form of
external evidence. While external evidence is considered the second most reliable evidence, an auditor’s direct personal knowledge (obtained through examination, re-computation, inspection, and observation) is the most reliable form of evidence.
PCAOB standards state that the relevance of audit evidences depends on
A. Whether the audit procedure is designed to directly test an assertion.
B. Whether the audit procedure is designed to test for an understatement or overstatement.
C. The timing of the audit procedure.
The auditor’s risk assessment affects
the nature, extent, and timing of audit procedures, but does not determine the relevance of audit evidence.
In order to obtain a reasonable basis for an audit opinion regarding the fairness of the client’s financial statements, the auditor should usually obtain and rely on evidence that is:
Persuasive because it is usually not possible or practical to obtain assurance beyond all doubt (100% of accounting data tested), the auditor should usually rely on audit evidence that is persuasive. Persuasiveness is a subjective concept, and is unique to each audit.
An auditor is in the process of gathering evidence during the current audit. Which of the following would not be considered corroborating evidence?
Sales invoices if an auditor reviews a client’s invoices, he or she would be examining the underlying accounting records of the client. Other underlying accounting records the auditor may review include contracts, ledgers, worksheets, checks, and journal entries.
An advantage of using statistical over nonstatistical sampling methods in tests of controls is that the statistical methods
Provide an objective basis for quantitatively evaluating sample risk. By using statistical sampling, the auditor can quantify sampling risk to assist in limiting it to a level considered acceptable.
The auditor decided to increase the level of the preliminary assessment of control risk because
the 7% tolerable rate (maximum rate of deviations that an auditor would be willing to accept without altering his/her planned reliance on the control) was less than the 8% upper deviation rate.
The risk of incorrect acceptance is an aspect of sampling risk that the auditor considers when
designing an audit procedure where sampling is used. This is considered before any potential misstatement is identified.
Qualitative factor that an auditor of a nonissuer may consider relevant when evaluating whether misstatements are material
A. The potential effect of the misstatement on the entity’s compliance with a contractual agreement.
B. The significance of the financial statement element affected by the misstatement.
C. The masking effect of the misstatement on a change in earnings in the context of industry conditions.
If the actual deviation rate in the population exceeds the maximum deviation rate based on the sample, control risk will be
understated, because the control will be less effective than sample results would indicate.
The missing invoice should be counted as a deviation, resulting in a 2% sample deviation rate.
However, this information alone is not sufficient to determine whether the control can be relied upon. The auditor would also need to know the
upper deviation rate or the allowance for sampling risk, which would allow the auditor to calculate the upper deviation rate). It is the upper deviation rate that needs to be compared to the tolerable rate in making decisions.
An auditor who uses statistical sampling for attributes in testing controls should reduce the planned reliance on a prescribed control when the:
Sample rate of deviation plus the allowance for sampling risk exceeds the tolerable rate.
Nonsampling risk includes all aspects of audit risk that are not due to sampling. Examples of nonsampling risk include
The auditor selecting inappropriate auditing procedures, using inappropriate audit evidence, and failure by the auditor to recognize misstatements in documents examined.
Stratified mean per unit (MPU) sampling is statical technique that mat be more efficient than unstratified MPU because it usually
produces an estimate having a desired level of precision with a smaller sample size
Probability Proportional Size (PPS) sampling, also known as dollar unit sampling is
The auditor controls the risk of incorrect acceptance by specifying that risk level for the sampling plan bc the inputs can be tolerable misstatements
The expected rate of deviation of the population to be tested is
one of the items the auditor considers when planning an audit sample for tests of controls.
When an auditor of a nonissuer uses statistical sampling techniques to perform a test of controls related to an assertion, factors that influence the sample size include
The expected rate of deviation of the population to be tested.
When testing a sample of an audit clients bank reconciliations during the year under audit, an auditor notices that several immaterial deposits in transit did not clear the bank in a timely manner
The auditor should consider the implications for the integrity of management or employees and the possible effect on the other aspects of the audit
The asset can not be tolerated if the projected error is
higher than the tolerable misstatement
The auditor selected a sample of every twentieth item. The overstatement is $3,700 and the understatement is $200.
- (1/20) = .05
- 3,700 - 200 =3,500
- 3,500 / .05 = 70,000
After identification of misstatements in the sample, the next step is to
be project the detected error to the entire population
An auditor randomly samples 50 out of 1,000 items and discovers an overstatement of $3,000. What is the projected misstatement for the entire population?
- (50 / 1,000) = 5%
- (3,000 / .05) = 60,000
An inner join uses only the records that
both data sets have in common. Therefore is there is any matching records in two data sets thats the answer.
Scatter plot allows
for the auditor to graphically show the relationship among variables. They allow for the regression lines to be added to show the direction and strength of correlation
Descriptive Analytics
describes what happened within the data. Aging the accounts receivable data would summarize and describe the data.
Diagnostic Analytics
explained why something happened.
Predictive Analytics
provide expected or predicted outcomes based on historical data.
Prescriptive Analytics
prescribe or recommend actions to be taken based on advanced analytics to reach a desired goal
Verifying assertions of accuracy and occurrence for all material transactions
are tested as part of substantive procedures
An auditor may apply audit data analytics (ADAs) when concluding an audit if
1) The auditor will have a deeper knowledge of the entity being audited and may reperform tests done in the risk assessment process
2) To gain comfort that no material misstatements went unidentified during the audit
3) To update existing analytics with numbers that were revised during the audit
Unstructured data is
social media posts because it is not organized and has a variety of data formats and types including texts, numbers, images, audio and video
When utilizing a graph
scaling is an appropriate consideration to avoid misinterpretation of differences
Data obtained through verbal interviews with fixed asset manager is considered
more reliable than data provided by client because data obtained directly by auditor is more reliable
An auditor is confirming accounts receivable using positive confirmations. The auditor decides to leave the accounts receivable amount blank rather than stating the amount owed. The auditor should be aware that the blank form may be less efficient because
Blank forms may result in lower response rates because a greater effort is required for response.
Sales personnel will have a tendency to maximize sales volume by selling to customers that may not be creditworthy, thereby resulting in
high bad debt write-offs. To prevent sales to customers that may not be creditworthy, employees involved in the credit-granting function are separated from the sales function.
Controls most likely would help ensure that all credit sales transactions of an entity are recorded
The billing department supervisor matches prenumbered shipping documents with entries in the sales journal.
Shipping documents provide evidence that
a sale occurred, and therefore selecting from a population of shipping documents allows the auditor to test whether corresponding invoices exist for each sale.
Preparing invoices and recording the related receivables are both recordkeeping functions that
would not be inconsistent with each other.
An accounting clerk receives customer payments and records the resulting reduction in accounts receivable.
This would allow the clerk to misappropriate cash while still reducing the receivable, such as in a lapping scheme.
The cashier performs the monthly bank reconciliation.
The purpose of a bank reconciliation is to uncover unexplained discrepancies between the bank balance and the cash on hand. If the reconciliation is not performed by someone independent, the cashier may be able to misappropriate cash and conceal the theft.
The purchasing manager approves vendor invoices for payment.
This would allow the purchasing manager to purchase and pay for unauthorized goods with little oversight from others.
The cash receipts clerk should not have both
record keeping responsibilities and custody of assets.
Preparing payroll checks and preparing the payroll register are both
recordkeeping responsibilities, so there is no violation of the concept of segregation of duties. Remember, until the checks are actually signed, they do not represent assets.
The accounts payable clerk should have access to the
purchase order, the receiving report, and the vendor invoice, in order to compare the three and determine whether the invoice is appropriate for payment.
Detecting a possible understatement in sales is tantamount to testing completeness (i.e., if an understatement is found, sales are not complete). To test completeness, one needs to start with
supporting documentation, such as shipping documents, and trace forward to recording in the accounting records, such as the sales invoices and sales journal. Should the auditor find a shipping document for which there is no entry in the sales journal, an understatement error (or a completeness problem) will have been discovered.
Sound internal control dictates that, immediately upon receiving checks from customers by mail, a responsible employee should:
Prepare a duplicate listing of checks received. Upon receipt of cash, a remittance listing should be prepared.
In evaluating the adequacy of the allowance for doubtful accounts, an auditor most likely reviews the entity’s aging of receivables to support the assertion of
valuation and allocation (i.e., to determine whether the allowance for doubtful accounts properly adjusts the receivables balance to net realizable value).
Evaluating the adequacy of the allowance for doubtful accounts does not pertain to existence. To support the assertion of existence, an auditor would most likely
confirm accounts receivable
completeness assertion
An auditor would trace from shipping records to the sales journal and the accounts receivable ledger to determine if all shipments were properly recorded as sales
The assertion of rights and obligations relating to accounts receivable would be supported by examining appropriate
supporting documentation, not by evaluating the allowance for doubtful accounts.
The completeness assertion is most closely related
to the completeness audit objective that verifies all sales have been recorded.
The occurrence assertion is most closely related to
the occurrence audit objective that verifies sales are valid
The accuracy assertion is most closely related to the
accuracy audit objective that verifies sales are properly valued.
The cutoff assertion is most closely related to the
timing audit objective that verifies sales are recorded in the correct accounting period.
Assertions about valuation and allocation deal with
whether asset, liability, revenue, and expense components have been included in the financial statements at appropriate amounts, and any resulting valuation adjustments are appropriately recorded. For example, management asserts that trade accounts receivable included in the balance sheet are stated at net realizable value.
Assertions about understandability of presentation and classification deal with whether
financial information is appropriately presented and described, and disclosures are clearly expressed. Reviewing credit ratings of delinquent customers does not provide evidence about this type of assertion.
Assertions about existence deal with whether
assets, liabilities, and equity interest of the entity exist at a given date. Reviewing credit ratings of delinquent customers does not provide evidence about this type of assertion.
Assertions about rights and obligations deal with
whether assets are the rights of the entity and liabilities are the obligations of the entity at a given date. Reviewing credit ratings of delinquent customers does not provide evidence about this type of assertion.
Cutoff tests are designed to determine whether transactions have
been recorded in the proper period.
Tests to detect credit sales made before the end of the year that have been (improperly) recorded in the subsequent year provide assurance about both cutoff and completeness (i.e., whether all current year sales have been properly included).
In recording fictitious sales, the client will likely have created
phony sales invoices, but no related shipment will have occurred.
A purchase order number is
unlikely to be used in an audit data analytic procedure related to the revenue cycle. A purchase order number is more likely to be used in an audit data analytic procedure related to the expenditure cycle.
Sending confirmations to customers is the most appropriate audit procedure to test
the existence of accounts receivable.
E-mail responses to requests for confirmations of accounts receivable present a problem to the auditor, since the
sender might not be as requested and the content might be altered. To reduce these risks, the auditor should request the senders to mail the original forms to the auditor.
Could improve the response rate of the confirmations of accounts receivable
Include a list of items or invoices that constitute the customers’ account balances. (Trying to make it easier for them to respond)
Confirmation responses received electronically should be
verified by calling the sender. It is possible for such responses to look like they came from the respondent when in fact they were actually generated by another party, such as the client.
Confirmations are not required if
the balance of receivables is immaterial.
What would be an appropriate alternative procedure when responses are not received.
Verification of subsequent cash receipts provides excellent evidence about year-end receivables
Negative confirmations only request a response when
the amount stated is incorrect, so there would be no need to perform additional procedures in this case.
In auditing accounts receivable the negative form of confirmation request most likely would be used when
The combined assessed level of inherent and control risk relative to accounts receivable is low.
Negative confirmation of accounts receivable is less effective than positive confirmation of accounts receivable because
The auditor cannot infer that all nonrespondents have verified their account information.
Two assertions for which confirmation of accounts receivable balances provides primary evidence are
Rights and obligations (does the client have a right to the receivable) and existence (does the receivable really exist)
Because of the significant discrepancies on past confirmations, the auditor would most likely choose to use
individual invoices there should be fewer discrepancies than confirmations sent out to customers in years past.
The auditor should perform alternative procedures on the confirmation selected since the client has a valid reason for requesting that the confirmation not be confirmed. An acceptable alternative procedure for accounts receivable confirmations is
verifying account balance by inspecting the client’s bank statements and cash receipt records.
The auditor would only increase detection risk in response to
a decrease in inherent and/or control risks, which is not the case here. Additionally, confirmation relates to the existence assertion, not the valuation assertion.
Confirmation of accounts receivable confirm the existence of the receivable. A lower than expected response rate could be indicative
of fictitious customer accounts.
Procedures would an auditor most likely perform for year-end accounts receivable confirmations when the auditor did not receive replies to second requests
Inspect the shipping records documenting the merchandise sold to the debtors.
When the shipping department returns nonconforming goods to a vendor, the purchasing department should send to the accounting department the
Debit memo to ensure that the accounts payable balance is reduced appropriately.
Controls should prevent an invoice for the purchase of merchandise from being paid twice
The check signer reviews and cancels the voucher packets.
Clerk 3 posts entered vendor invoices to the accounts payable ledger for payment and mails checks.
This indicates a weakness in internal control as the accounts payable clerk has both the record keeping and custody functions. To mitigate this control weakness, clerk 3 can have responsibility for posting invoices to the ledger, but the Treasurer should be the person that mails the checks, which is part of the custody function.
To provide assurance that each voucher is submitted and paid only once, an auditor should
verify that each voucher was stamped “paid” by the check signer.
Auditor confirmation of accounts payable balances at the balance sheet date may be unnecessary because
There is likely to be other reliable external evidence available to support the balances.
In auditing accounts payable, an auditor’s procedures most likely would focus primarily on management’s assertion of
Completeness, when testing liabilities, an auditor generally is concerned about understatement (as opposed to overstatement, for assets). Therefore, in auditing accounts payable, an auditor’s procedures most likely would focus primarily on management’s assertion of completeness if accounts payable is not complete it would be understated).
Which of the following procedures would an auditor most likely perform in searching for unrecorded payables
compare cash payments occurring after the balance sheet date with the accounts payable trial balance to determine that disbursements that pertain to the prior year’s business (year under audit) have been properly accrued. This procedure is commonly known as an “out-of-period-search.”
Performing a search for unrecorded payables, an auditor most likely would examine
cash disbursements recorded after the balance sheet date to determine whether the payables related to the prior period have been included in the accounts payable trial balance.
Procedures would an auditor most likely perform in searching for unrecorded payables
Compare cash payments made after the balance sheet date with the accounts payable trial balance.
Auditor most likely perform in searching for unrecorded liabilities
Vouch a sample of cash disbursements recorded just after year-end to receiving reports and vendor invoices.
When testing the completeness assertion for accounts payable, the appropriate population would be
a list of vendors with whom the entity has previously done business.
Inventory is relatively
predictable with respect to amount, composition and relative significance.
Accounts payable is relatively
difficult to predict because it may fluctuate at management’s discretion.
During planning, the auditor is required to obtain an understanding of the entity and its environment, including
its internal control, and to assess risk. Such preliminary planning is often conducted prior to the balance sheet date.
Audit testing at interim dates may permit early consideration of significant matters affecting the year-end financial statements
such as the identification of related parties.
Procedures would best detect a liability omission by management
Review purchase contracts and other legal documents. (for example, an obligation to make a certain purchase, or a document evidencing a lawsuit).
If employee is destroying the invoices and related vouchers, the most obvious documentation remaining would be
the file of all cash disbursements. The auditor would select items from this file and then attempt to trace from specific cash disbursements to the related invoices and approved vouchers. Missing documentation might be indicative of fraud.
Internal control activities usually performed in the vouchers payable department
A. Matching the vendor’s invoice with the related receiving report.
B. Approving vouchers for payment by having an authorized employee sign the vouchers.
C. Indicating the asset and expense accounts to be debited.
Mailing disbursement checks and remittance advices should be controlled by the employee who
Signs the checks last
Approved purchase order
The authority to accept incoming goods in receiving should be based on
The purchasing department is responsible for
preparing the purchase order, the accounts payable department is responsible for matching documents, and the treasurer is responsible for making payment.
For effective internal accounting control, the accounts payable department should compare the information on each vendor’s invoice with
Receiving report and the purchase order
The most effective control activity to detect vouchers that were prepared for the payment of goods that were not received
is to match the purchase order, receiving report, and vendor’s invoice for each voucher in the accounts payable department.
On receiving a client’s bank cutoff statement, an auditor most likely would trace
The auditor should obtain bank cutoff statements that include transactions for 10 to 15 days after year-end. The outstanding checks and deposits in transit at year-end on the bank reconciliation should agree with the information in the bank cutoff statement.
Which characteristics most likely would be indicative of check kiting
Low average balance compared to high level of deposits.
Kiting occurs when a
check drawn on one bank is deposited in another bank and no record is made of the disbursement in the balance of the first bank.
An auditor should trace bank transfers for the last part of the audit period and first part of the subsequent period to detect whether:
cash balances were overstated because of kiting (concealing a cash shortage by depositing in one bank an unrecorded check of another disbursement bank, effectively recording the same funds in both bank accounts).
The primary purpose of sending a standard confirmation request to financial institutions with which the client has done business during the year is to:
Corroborate information regarding deposit and loan balances.
The standard confirmation request seeks
information on contingent liabilities and security agreements in addition to information related to deposit account balances.
The usefulness of the standard bank confirmation request may be limited because the bank employee who completes the form may:
Be unaware of all the financial relationships that the bank has with the client.
The ________ should control the mailing of independent confirmations.
auditor
The primary evidence regarding year-end cash balances in the financial statements is documented in the:
Bank reconciliations
An auditor generally tests the segregation of duties related to inventory by:
Personal inquiry and observation are auditing procedures commonly used to test segregation of duties.
The control objective of verification of the existence of inventory is achieved when
reviewing and testing control procedures over the physical inventory count. In a physical inventory count, the auditor inspects the inventory to verify its existence and condition.
An auditor reviews the overhead allocation to determine that
no excessive costs for idle plant were charged to inventory. This is one of the procedures performed by an auditor to determine that the inventory balance is properly valued (assertion of valuation and allocation).
When an auditor selects items for test counts and traces the test counts to the client’s inventory listing
the auditor has obtained evidence concerning management’s assertion of completeness (All inventory on hand has been properly included in the physical listing.)
In order to determine whether the actual inventory on hand is reflected in the ending inventory balance by the client, the auditor would test the
completeness of inventory. This is done in conjunction with inventory observation, through testing the physical inventory report by tracing test counts to the report to verify that reported inventory is complete.
Examining an analysis of inventory turnover helps identify
slow-moving, excess, defective, and obsolete items included in inventories. In order for inventory to be properly valued, these items may need to be written down.
Failure to record sales returns would result in
actual inventory quantities being greater than those recorded in the perpetual inventory records.
Testing the entity’s computation of standard overhead rates generally provides assurance about a
client’s inventory valuation.
In order to maintain accurate perpetual inventory records
periodic inventory counts should be used to adjust perpetual records
The auditor should observe the physical inventory count of goods held in public warehouses if the inventory held therein is
significant; otherwise, confirmation of such inventory is sufficient.
The directional test of tracing is generally used to
test completeness. In this case, tracing the inventory tags to the computerized list of inventory items is a test of the completeness of the inventory list.
Testing the computation of standard overhead rates relates to the
accumulation of costs during the manufacturing process, and not to whether the inventory is slow-moving, defective, or obsolete after manufacture.
Segregation of duties between customer invoicing and inventory valuation would be an effective control for
detecting misstatements of inventory item pricing schedules.
what is an effective control to detect misstatements of inventory item pricing schedules
1) Comparison of sales invoices to price lists effective internal control activity
2) Comparison of groups of items to sales reports and subsequent investigation of unusual variances
Performing cutoff procedures provides assurance that
goods in transit (shipped or received) are appropriately included or excluded from inventory and this procedure is most appropriate for testing the completeness assertion.
Tracing from the inventory listing to the inventory tags and the auditor’s recorded count sheets verifies the
validity (existence) of the items.
In addressing the adequacy of presentation and disclosure for inventory, the auditor should determine that
inventory-related obligations, such as inventory pledged under loan agreements, have been properly disclosed.
In testing long-term investments, an auditor ordinarily would use
analytical procedures to ascertain the reasonableness of the completeness of recorded investment income. These procedures would probably include a comparison of the recorded investment income with the expected amount (based upon the related interest rate, dividends declared, etc.) and the income balance audited in the prior year.
An independent person comparing the contents of the safety deposit box with the recorded balances in the investment subsidiary ledger is
an effective control for assuring that the proper custody of assets in the investing cycle is maintained.
The control most likely to be used by an entity in safeguarding against the loss of marketable securities is that an independent trust company that has no direct contact with the employees who have recordkeeping responsibilities, has possession of the securities. For good internal control over the safeguarding of any asset,
the individual who has the recordkeeping responsibilities over that asset should never have access to it.
Requiring the internal auditor to compare the securities in the bank safe deposit box with recorded investments is the procedure an entity most likely would use in
satisfying the completeness assertion related to long-term investments.
After performing a count of negotiable securities, the auditor would generally obtain an acknowledgment from the client that the securities were returned intact. This helps maintain
accountability for the securities, and reduces the likelihood of employee misappropriation (e.g., if a client employee were to steal a security and blame the auditor).
A confirmation from an outside agent indicating that securities are being held in the client’s name provides evidence
both the existence assertion and the rights and obligations assertion.
Dividend income from investments is tested by referring to the
dividend record books produced by investment advisory services, such as “Moody’s Dividend Record.” These books state the dividend that was declared and paid by the investee.
Confirmations should be requested from the
custodian for securities that are in the possession of third parties.
An auditor should verify the valuation of marketable securities at the balance sheet date by
comparing the prices of the securities with published closing prices at the balance sheet date.
If the auditor is unable to count the securities at the balance sheet date the auditor should
request the client to have the bank seal the safe deposit box until the auditor can count the securities.
Electronically accessing the details of dividend records on the Internet is an efficient means of
verifying dividend rates for multiple investments in a short amount of time.
Under equity method accounting, the amortization of the excess of the investor’s cost over the investment’s underlying book value reduces the investor’s income from the equity method investment if
amortization is calculated incorrectly (i.e., the amortization is too high), this could lower the return on the investment.
If the quotation to support a fair value estimate is from the broker who initially sold the instrument, the evidence might be less objective and might need supplementation. The broker may be
biased because the broker sold it to the entity and may overstate the value of the instrument.)
The best evidence of fair value pertaining to a client’s investments in derivative instruments that are listed on a national exchange and disclosed at fair value is
to verify the quoted market values on that exchange.
The auditor would consider subsequent events and transactions occurring before
the completion of the audit, not after. The auditor is not responsible for predicting the future, and would not be expected to evaluate the effect of conditions arising subsequent to the audit, that, if known at the time of the audit, might have affected fair value measurements and disclosures.
In auditing investments in securities and derivatives, the auditor must assess the
reasonableness and appropriateness of assumptions, market variables, and valuation models. In order to do this, the auditor must consider whether the substance of transactions or events differs materially from their form. Remember that generally accepted accounting principles require transactions and events to be reported in accordance with their economic substance, even if this differs from their form.
Generally accepted accounting principles specify that, in order to qualify for hedge treatment, the entity must demonstrate and disclose
a number of transaction features including risk exposure. The auditor would therefore need to examine the contracts to evaluate the character of the hedge and the degree to which losses should be recognized in the determination of income, as well as the character of any disclosures.
In a search for unrecorded disposals, the auditor would
vouch a sample of assets on the property ledger to those on hand in the client’s facility.
Comparing interest expense with the bond payable amount for reasonableness provides evidence that
all interest expense was included and that the outstanding balance of the bonds payable is reasonable, as well as providing limited evidence concerning the amortization of bond discounts or premiums.
Completeness is the assertion supported by the auditor tracing
the serial numbers on equipment (source) to a nonissuer’s sub-ledger (book).
Since control risk is assessed at a low level, tests of controls would be required to
evaluate the effectiveness of the internal controls to support that assessed level. Assuming controls are operating effectively, only limited substantive testing would be performed.
Questions relating to access controls for assets would not normally be a part of a
questionnaire related to controls over the initiation and execution of equipment purchases.
Investigation of variances in a formal budget might show
maintenance costs over budget or acquisition costs under budget, either of which would trigger an investigation.
Determining that proper amounts of depreciation are
expensed provides assurance with regard to valuation and allocation related to the asset, and accuracy in terms of financial statement presentation.
Analysis of repairs and maintenance expense provides
assurance with regard to management’s assertion that expenditures for property and equipment have been capitalized and have not been charged to expense.
What is an example of obtaining evidence concerning management’s assertion of existence.
By examining the assets listed as new additions on an analysis of plant and equipment, an auditor
The explanation that plant assets were retired during the year would most likely satisfy an auditor who questions management about
significant debits to accumulated depreciation accounts made during the year. The journal entry to retire an asset includes a debit to accumulated depreciation and a credit to the asset account.
In order to obtain evidence about fixed asset additions, an auditor would most likely inspect
documents (e.g., purchase invoices) and physically examine the new assets.
Tracing (old) equipment recorded in the books to the actual equipment during a plant tour is a control which tests for
unrecorded retirements.
If an auditor discovers that the original insurance policy on plant equipment is not available for inspection, this most likely indicates that there is
a lien on the plant equipment, since the original policy would likely be in the possession of the lien holder.
The purpose of segregating the duties of hiring personnel (personnel department/human resources) and distributing payroll checks (treasurer’s department) is to separate
the authorization of transactions (hiring, pay rates, etc. are authorized by the personnel department/human resources) from the custody of related assets (cash or checks are held in the treasurer’s department)
The occurrence assertion as it relates to payroll transactions would correspond to an audit objective to determine that
payroll transactions actually occurred (i.e., that all payroll checks were issued to valid employees for hours actually worked). Segregation of duties between personnel and payroll departments is an important control to ensure that only valid employees receive paychecks.
The use of time tickets to record actual labor worked on production orders is the best way to
prevent direct labor from being charged to manufacturing overhead.
A direct supervisor’s approval of the time cards most effectively ensures that payment is paid for
work performed as the supervisor observes the employees and determines whether employees are present and working.
An auditor most likely would perform substantive tests of details on payroll transactions and balances
when analytical procedures indicate unusual fluctuations in recurring payroll entries.
If the control risk is assessed as low
less substantive testing is necessary. In such an instance, substantive testing would normally be limited to analytical procedures and recalculating year-end accruals.
In auditing the granting of stock options, the auditor would normally
trace the transactions to approval by the board of directors.
An internal control questionnaire for notes payable would likely ask if
direct borrowings on notes payable are authorized by the board of directors.
An auditor’s purpose in reviewing the renewal of a note payable shortly after the balance sheet date most likely is to obtain
evidence concerning management’s assertions about understandability of presentation and classification (i.e., classification of the note as current or noncurrent).
Examination of bond trust indentures should be included in audit program of
long-term debt to assure that the client was not in violation of any covenants in the indentures.
The auditor should trace corporate stock issuances and treasury stock transactions to the
minutes of the board of directors to make sure they were authorized.
If a client uses a stock transfer agent, confirmations should be used to provide evidence of
shares authorized, issued, and outstanding, as well as to provide evidence of the individual transactions.
Quantitative data is
numbers-based, countable, or measurable.
Qualitative data is
interpretation-based, descriptive, and relating to language
According to PCAOB standards which statement does not reflect a qualitative standard that should be considered when evaluating the MATERALITY of an uncorrected misstatement
The dollar amount of the error.
The auditor should document the errors in the summary of
uncorrected errors, and document the conclusion that the errors do not cause the financial statements to be misstated.
When determining whether uncorrected misstatements are material, individually or in the aggregate, an auditor of a nonissuer or issuer would consider each of the following
1) The particular circumstances of each misstatement.
2) The effect of uncorrected misstatements related to prior periods.
3) The size and nature of the misstatements.
The misstatement of failing to disclose $45,000 of related party transactions is quantitatively immaterial because it is less than the overall materiality of $125,000. However, this misstatement is likely to be considered qualitatively material.
Related party transactions can occur at terms that are significantly different from those for transactions that occur at arm’s-length. Therefore, it is important that users of the financial statements be provided with information about related party transactions, even if the amount is less than materiality, as it helps represent the true picture of the company.
The auditor prepares the summary of unadjusted differences. Management’s responses to inquiries cannot be verified by the auditor by merely taking their statements and filling out a summary sheet of misstatements.
Misstatements recorded on the summary should be supported by additional evidence (e.g., inspection of documents, observations). Inquiry alone is not sufficient.
If liabilities are not recorded, then liabilities are
understated (i.e., the balance is not complete). The other side of the journal entry for accounts payable is typically expense. If expenses are not recorded, this means that income is overstated.
Management should address written representations about a firm’s annual audit to
the auditor
The date of the representation letter should typically be
the same as the audit report
The auditor should consider the implications of an act of noncompliance with
laws and regulations in relation to other aspects of the audit, particularly the reliability of representations of management.
The auditor might discuss with those charged with governance management’s
consultation with other accountants, but representations about such consultation are not required.
“We disclosed to you all known instances of non-compliance or suspected non-compliance with laws and regulations whose effects should be considered when preparing financial statements.” The foregoing passage is most likely from
information will be disclosed in a management (client) representation letter.
Management acknowledges its responsibility for the
design of controls to detect and prevent fraud in its management representation letter.
The representation letter should include
management’s belief that the effects of any uncorrected financial statement misstatements aggregated by the auditor during the current engagement and pertaining to the latest period presented are immaterial, both individually and in the aggregate, to the financial statements taken as a whole.
Specific written representations obtained by the auditor should include a statement that the
significant assumptions used by management in making accounting estimates are reasonable.
The purpose of the management representation letter is to
confirm management’s oral evidence supplied during the engagement. Specific written representations obtained by the auditor might include acknowledgment that all compensating balances or other restrictions on cash have been disclosed.
Conditions noted by the auditor that are significant deficiencies or material weaknesses should be reported in writing. Any report issued on such conditions should
(1) indicate that the purpose of the audit was to report on the financial statements and not to provide an opinion on internal control; (2) include the definition of a material weakness and, if applicable, significant deficiency; (3) include a restriction on use (i.e., the report is intended solely for the information and use of management, those charged with governance, etc.).
If those charged with governance are not involved with managing the entity, the auditor should
communicate material, corrected misstatements brought to management’s attention as a result of the audit
The auditor should communicate with
those charged with governance regarding the planned scope and timing of the audit.
Deficiency in operation exists when
a properly designed control is either not executed as designed or the person performing the control does not have either the authority or the skill to perform the control. In this case, the clerk did not have the necessary authority to follow through on the control.
If employees have the opportunity to change their time worked after their time cards are approved, this represents
a deficiency in the design of the control. The control design is deficient because it should not allow employees to change their time worked after their time cards have been approved.
Because timely communication may be important, the auditor may choose to communicate
significant deficiencies during the course of the audit rather than after the audit is concluded.
A material weakness is
a deficiency, or combination of deficiencies, such that there is a reasonable possibility that a material misstatement of the entity’s financial statements will not be prevented or detected/corrected.
An auditor’s communication of internal control related matters noted in an audit usually should be addressed to
management and those charged with governance.
A previously communicated significant deficiency that has not been corrected ordinarily should be communicated
again in writing, during the current audit
The auditor is not required to
search for significant deficiencies (but any that are identified should be reported).
The auditor may not report the absence
of significant deficiencies to those charged with governance or management.
The report should state that the communication is
intended solely for the use of management, those charged with governance, and others within the organization.
The auditor should separately identify
significant deficiencies and material weaknesses
A review of the interim financial information of a publicly held company is conducted in accordance
with РСАОВ standards
The objective of a review of interim financial information is to provide the accountant, through
inquiries and analytical procedures, with a basis for reporting whether material modifications should be made to such information to conform with generally accepted accounting principles.
Considering the results of audit procedures that have previously been performed and how they correspond to the current year’s financial statements is a step that may be performed during
the planning stage to update the accountant’s knowledge of the client.
This statement would likely be found in an
engagement letter, not a management representation letter.
Review requires inquiry of the client’s attorney regarding
litigation, claims, and assessments, although it may be appropriate in certain circumstances.
A review report on the interim financial information of a publicly held company
does not provide an opinion on the financial statements.
If the client refuses to accept the CPA’s suggestions, the CPA should
add a paragraph modifying the disclaimer to describe the nature and effect of the departure from GAAP.
If a report on a review of interim financial information is presented in a registration statement, the prospectus should include a
statement that the report is not a “report” or “part” of the registration statement. The accountant should also read the other portions of the registration statement to ensure that his or her name is not used in a way that indicates greater responsibility than he or she intends.
When an independent accountant’s report based on a review of interim financial information is presented in a registration statement, the prospectus should include a statement
clarifying that the accountant’s review report is not a “part” of the registration statement within the meaning of the Securities Act of 1933.
An accountant may issue a review report on one financial statement, such as
a balance sheet, as long as the scope of the inquiry and analytical procedures has not been restricted.
An accountant is not required to obtain an
understanding of internal control in a compilation and review engagement.
