Ch 11 Flashcards
Auditors tests of controls determine…
1 The operating effectiveness of internal control
2 assess control risk
3 assess risk of material misstatement
Auditors use the audit risk model to…
Limit exposure to audit risk
Auditors use substantive procedures to determine…
Fairness of account balances and classes of transactions
At the end of an audit, chances of audit failure are…
At their highest
5 questions auditor should be asking when audit is concluding
1 have year-end misstatements that significantly affect the financial statements been identified?
2 what events that occur after date of financial statements
Could affect current year statements?
3 pending exposure of client to litigation?
4 has client provided all relevant info to auditors during engagement?
5 what matters need to be discussed with individuals charged
With governance of client (audit committee)?
Audit timeline: throughout the year what interim testing should be performed? 2
1 test of controls
2 substantive procedures
Audit timeline: 7 items that must be addressed at year end
1 completing substantive procedures 2 attorneys' letters 3 written representations 4 going concern assessment 5 adjusting journal entries 6 audit documentation review 7 subsequent events
Audit timeline: what must be looked for before the audit completion date?
Subsequently discovered facts
Audit timeline: what 4 items should be looked over before the audit report release date?
1 subsequently discovered facts
2 omitted audit procedures
3 management letter
4 communications with those charged with governance
4 important periods on audit timeline
1 beginning of the year
2 year end date (date of financial statements)
3 date of auditors report (audit completion date)
4 audit report release date
When does interim testing go through?
From January 1st to December 31st
Date of financial statements
The year-end date of the latest period covered by the client’s
Financial statements
Date of the auditors report
Date where auditors have gathered sufficient appropriate evidence
On which to base their opinions on financial statements and
Internal control over financial reporting
Date that will be used for auditors’ reports on client’s financial
Statements and internal control over financial reporting
Audit report release date
Date on which auditors allow client to use their reports in
Conjunction with the financial statements
Same date on which client’s financial statements are issued
Usual period between date of financial statements and date of auditors report?
December 31st to February 15th
Challenge for auditors with audit release date
Auditors can no longer actively obtain evidence
Dilemma: how to report new development in this short period,
Without increasing responsibility of other (unknown) developments
When issues come to auditors’ attention after audit report release date, what can the auditor due in general?
Auditor can take steps to ensure third parties do bit inappropriately
Rely on auditors reports that are no longer reliable
Auditors often test account balances at interim date for…
Efficiency reasons
Roll-forward procedures, define, give a common example
Procedures performed by auditors to extend that conclusions
From an interim date to the date of financial statements
Ex. Examining material account transactions that occur between
Interim testing date and date of financial statements
What do analytical procedures allow auditors to do?
Evaluate financial info by studying relationships among both
financial and nonfinancial data
When must public companies file annual reports with the SEC?
Within 60 days after date of financial statements
When can analytical procedures be used throughout he audit according to AU 520? 3
1 during planning
2 part of substantive testing
3 near end of audit as overall review
Purpose of Analytical procedures: during planning
Assist auditors in planning nature, timing and extent of other audit procedures
Purpose of Analytical procedures: part of substantive testing
Obtain audit evidence about particular assertions related to
account balances or classes of transactions
Purpose of Analytical procedures: near end of audit
As overall review of financial info
To assess conclusions reached and evaluate the overall financial
Statement presentation
Analytical procedures to review financial statements and footnotes, what do auditors evaluate? 4
1 adequacy of evidence gathered in response to unexpected
Account balances
2 relationships among account balances Identified during audit
3 unusual/unexpected acct. balances
4 relationships w/account balances that were not previously
identified In other parts of audit
Key to detecting fraud toward end of audit?
If industry averages are tanking, yet the client’s profit ratios
Are increasing warrants gathering additional audit evidence
What should auditors be alert for pertaining to revenue and expense accounts?
Alert for “miscellaneous”, “other” or “clearing” classified as
Revenue or expense accounts
Particular when adjustments are made at end of period
How can over reporting of revenue/under reporting of expenses be detected?
By scanning accounts for large unusual entries
Earnings management
Adjustments to meet analyst expectations
If items pertaining to earnings management are identified, what should the auditor do?
Auditors should exam related documents
and inquire with client to verify that classification of revenue
Or expense is appropriate
6 Critical accounting estimates for retailers
1 inventory markdowns 2 asset impairment 3 sales returns 4 A/R allowance for doubtful accounts 5 benefits for customer loyalty programs 6 gift card usage
Because estimates reflect uncertainty and future outcomes, auditors cannot…
2) what should auditors consider about estimates?
Audit, corroborate or verify accounting estimates
2) auditors should consider whether estimates are reasonable
What do auditors do relating to management’s estimates near the end of the audit? 2
1 evaluate management’s process for developing reasonable
Estimates
2 determine reasonableness of estimates using historical and
Industry data
Contingency, define
Examples
Existing condition, situation or circumstances involving uncertainty
Of possible gain or loss to an enterprise
Will be resolved if 1 or more future events occur or fail to occur
Ex. Warranties, tax disputes with IRS, guarantees on debt from
Another party
With respect to contingencies, auditors should ensure… 2 things
1 all contingencies are appropriately identified
2 any client disclosure of contingencies reflects most current info
On recent developments both favorable and unfavorable to client
2 important issues from an auditors standpoint relating to pending litigation, claims, assessments
1 have been disclosed to auditors
2 are properly presented and disclosed in client’s financial
statements
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
obtain from management a description and evaluation of…
Litigation, claims and assessments
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
Examine documents in the client’s possession concerning litigation, claims and assessments including…
Correspondence and invoices from client’s attorneys
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
Obtain assurance from management that it has disclosed all material unasserted claims…
The attorney has advised them are likely to be litigated
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
Read minutes of meetings of…
Stockholder’s, directors and appropriate committees
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
What contracts are read? 3
1 loan agreements
2 lease agreements
3 correspondence from taxing or other government agencies
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
Obtain information concerning guarantees from…
Bank confirmations
Once an inquiry with management has been made to discuss potential litigation, claims and assessments; procedures auditors perform:
3 things that should be reviewed relating to legal services?
1 legal expense account
2 cash disbursements records
3 invoices related to legal services
When auditors assess a risk of material misstatement from pending litigation, claims and assessments, they will request their client send…
An attorney letter to all attorneys who worked for the client
During the period under audit
Attorney letter
Communication prepared by client but sent by auditors to client’s
Attorneys that details all pending litigation, claims and assessments
Against client
Waives attorney-client privilege so attorneys can comment on
These matters directly to client’s auditors
4 pieces of information the attorney letter should contain (prepared from the client’s perspective)
1 list of pending or threatened litigation, claims or assessments
2 description of each item (nature of case, management’s response
Or planned response)
3 evaluation of likelihood of unfavorable outcome
4 estimate of range of potential loss
3 steps of attorney letter correspondence
1 letter prepared by client
2 mailed by auditors
3 attorney’s response directly to auditors
4 responsibilities of auditors in audit of litigation, claims and assessments
1 inquire of client regarding existence of litigation, etc.
2 perform various procedures regarding litigation, etc.
3 initiate request to client for attorney letter
4 mail attorney letter prepared by client
3 responsibilities of client in audit of litigation, claims and assessments
1 respond to auditors’ inquiries regarding litigation, etc.
2 provide auditors list, description and evaluation of litigation, etc.
3 prepare letter to attorney that includes info related to litigation, etc.
responsibility of attorney in audit of litigation, claims and assessments
Respond to auditors regarding client’s description of litigation,
Claims and assessments contained in attorney letter
What raises additional issues for attorney letters?
Unasserted claims
Unasserted claim
Represents that no formal lawsuit/claim has been filed or
Threatened on behalf of others
But circumstances such as catastrophe, accident or other
Physical occurrence could result in suit/claim filed in future
What must attorneys consider in regard to unasserted claims when responding to attorney letters?
1 Likelihood that lawsuit/claim will be filed
2 possibility of unfavorable outcome
When should attorneys recommend client’s disclose unasserted claims to auditors?
When assertion of claim is at least probable
Written representations, where must they be included? What must they include?
In 10K and 10Q, must include certifications from CEO and CFO
Related to fairness of financial statements
and effectiveness of Internal control
AU 580, requires auditor obtain written representations (AKA Management representations AKA client representations) to…
Confirm certain matters and support other evidence obtained during the audit
Completion of the audit depends on date…
Auditors receive written representations from management
Therefore events of written representation run up to date
Audit is completed
3 sections of a written representation
1 entities financial statements
2 info provided to auditors
3 internal control over financial reporting (for public entities)
Written representation: the entities financial statements section, 3 things it includes?
1 management’s responsibilities for financial statements and
Internal control over financial reporting
2 appropriate disclosure, presentation and reasonableness
Of items
3 statement that uncorrected misstatements are immaterial to
Financial statements taken as a whole
Written representation of financial statements: the appropriate disclosure, presentation and reasonableness of certain items 4 things
1 accounting estimates
2 related parties
3 subsequent events
4 litigation and claims
Written representation: information provided to auditors, both in general and related sensitive areas, 4 things
1 fraud
2 noncompliance with laws and regulations
3 litigation
4 related party transactions
Management’s refusal to furnish written representations constitutes a…
2) What does this require?
Scope limitation
2) Which requires a qualified opinion on auditors report or disclaimer
Of opinion
4 pieces of information that indicates client may have trouble continuing as a going concern
1 negative trends
2 financial difficulties
3 internal matters
4 external matters
Going concern: negative trends 3
1 Recurring operating losses
2 working capital deficiencies
3 negative Cashflow from operations
Going concern: financial difficulties 4
1 Default on loans
2 denial of credit from suppliers
3 restructuring of Debts
4 arrearages in dividends
Going concern: internal matters 2
1 work stoppages
2 substantial dependence on success of particular project/activity
Going concern: external matters 3
1 legal proceedings
2 loss of key franchise, license or patent
3 loss of major customer or supplier
Substantial doubt as going concern
Auditors required to consider whether any evidence comes to their
Attention of if company can’t continue 1 year beyond date of audit
If auditors evaluation suggests going concern uncertainties, auditors should obtain information about…
Management’s plans to mitigate the effect of these factors
And assess the likelihood it can be effectively implemented
3 ways management may be able mitigate going concern uncertainties
1 reduce expenditures
2 restructure existing debt
3 access additional sources of financing
In all cases where going concern uncertainties exist, what 3 items will be found on audit documentation?
1 conditions or events that suggest going concern uncertainty
2 management’s plans to mitigate going concern uncertainty and
Audit procedures to evaluate management’s plans
3 auditors conclusion to whether substantial doubt exists for
Business to continue
Who are the footnotes of financial statements the responsibility of?
Management
Even when the failure to adjust financial statements would result in materially misstated financial statements, does the client have to accept the auditors’ adjustments?
No, it is The client’s decision whether to accept the proposed adjustments
What are Adjustments to footnotes suggested by auditors but not yet made by management called?
Proposed adjustments
Uncorrected misstatement
Misstatement that auditors have identified and accumulated during
Audit
Client has not corrected or adjusted misstatement, often because
Of materiality or cost benefit decisions
How many uncorrected misstatements occurred before and after SOX?
Before 75% stayed uncorrected
After SOX 24.2% stayed uncorrected
Staff Accounting Bulletin No. 99: immaterial misstatements
Should be adjusted because over the years they may become
material
2 methods auditors use to evaluate materiality of uncorrected misstatements
1 roll over method
2 iron curtain method
Rollover method
Process used when evaluating effect of uncorrected misstatements
Considers only the current period income effect of potential
Adjustment
Iron curtain method
Process used when evaluating the effect of uncorrected
misstatements
Considers aggregate effect of current and prior misstatements
In entity’s balance sheet
Staff Accounting Bulletin no. 108, what does it require auditors to do?
Evaluate misstatements using both the roll over method and
Iron curtain method
Who are auditors required to communicate all misstatements detected during the audit?
The client’s audit committee (or other individuals charged with
Governance)
3 purposes of audit document review by audit partner and audit manager?
1 ensure all steps of audit plan performed
2 referencing among audit documentation is clear
3 audit documentation is understandable
Supervisor’s main purpose in audit document review? 2
Determine that work was performed with due care
And work can be re performed and verified by another party
Common outcome of audit documentation review
Review notes prepared by audit supervisor to be completed
By audit staff
What do review notes address?
Procedures performed referencing audit documentation
And appropriateness of staff member’s conclusions
Engagement quality reviewer
GAAS requires audit documentation be reviewed by additional
Person
Usually an audit partner who has not been involved with the
Audit
What does the review of the engagement quality reviewer focus on?
Focuses on significant judgments made by the engagement team
And conclusions reached in preparing auditor’s report
4 Benefits of audit documentation review
1 ensures audit conducted in accordance with GAAS
2 evaluate quality of firm’s audit practice (method of quality control)
3 important component of training/evaluation of audit staff members
4 adhere to performance principle to adequately plan/supervise
Work
Fairness of entity’s financial statements: subsequent events
Before auditor report is issued, Auditors should consider impact
of subsequent events on fairness of financial statements
Subsequent events
Events occurring between the date of financial statements
And date if auditor’s report
Auditor’s primary objective with respect to subsequent events
Ensure any material events that effect fairness if client’s financial
Statements and disclosures are properly identified
and disclosed in client’s financial statements
AU 560 subsequent events: date of financial statements
Events that provide additional evidence of conditions that existed
At date of financial statements
Ex. Deteriorating financial condition of client’s customer that had
Large A/R balance
AU 560 subsequent events: following date of financial statements
Events that provide evidence of conditions that arose following
Date of financial statements
Ex. Major acquisition occurring after date of financial statements
AU 560 identifies the following procedures that should performed to identify existence of material subsequent events:
Obtain an understanding of procedures management preformed to…
Identify material subsequent events
AU 560 identifies the following procedures that should performed to identify existence of material subsequent events:
Inquire of management and those charged with governance as to the existence of…
Subsequent events
Inquiry should be corroborated with written representations
AU 560 identifies the following procedures that should performed to identify existence of material subsequent events:
Read minutes of meetings of…
Owners, management or those charged with governance held after
Date of financial statements
AU 560 identifies the following procedures that should performed to identify existence of material subsequent events:
Review entity’s latest…
Interim financial statements, if applicable
When material subsequent events are identified, auditors are required to…
Ensure financial statement disclosure reflects all current information
According to GAAP
Subsequently discovered facts
Facts know to auditors after the date of audit report
If known before date of audit report, auditor would have revised
Report
Subsequently discovered facts before the auditor’s report is issued: change date on auditor’s report to reflect new later date, disadvantage?
Auditor’s responsibility for all events is now extended to later date
Dual date, define
When is it used?
Give 2 dates on auditor’s report
When facts are discovered following date of auditor’s report but
Prior to audit report release date, auditors normally choose to dual
Date the report
2 important functions dual dating serves?
1 provides way to modify financial statements and disclosures
For info discovered after date of auditor’s report
2 it limits auditor’s liability for events after date of auditor’s report
To events specifically identified in the report date
Subsequently discovered facts, do auditors always need to evaluate their effect?
No, auditors can choose not too
What happens when subsequently discovered facts occur after issuing of the auditors report?, 2 actions client must take
1 notify individuals relying on financial statements that they should
not be relied upon and new Statements with auditors reported will
Be issued
2 issue revised financial statements as soon as practicable with
Appropriate disclosure of matter related to subsequently discovered
Fact
What happens when subsequently discovered facts occur after issuing of the auditors report and management refuses to take 2 required actions?
Auditors should notify management, regulatory agencies or any
Individuals relying on financial statements
That auditor’s report can’t be relied upon
If subsequently discovered facts would require revision of financial statements, what should be included in auditors notification (after client has refused to take 2 necessary actions)?
Nature of matter and effect on financial statements should be
Included in auditor’s notification
Although auditors have no responsibility to continue to review their work after the audit report release date, auditor’s reports and audit documentation may be subjected to…
PCAOB inspection, external peer review
or firm’s own internal Inspection program as part of its quality
control
What does Section 104 of SOX require?
Inspections of audit work to be conducted annually by PCAOB
if firm provides services for over 100 clients
Inspections every 3 years if less than 100 clients
Omitted procedures
When auditors failed to perform necessary audit procedures
Prior to audit report release date
AU 585’s 2 points of guidance about when omitted procedures should be performed
1 if omitted procedures are important in supporting auditor’s
Opinion
2 individuals are currently relying on the client’s financial statements
And auditor’s report, assuming omitted procedures are relevant
Individuals charged with governance
Persons responsible for overseeing client’s financial reporting
process including the internal control of financial reporting
Typically audit committee of board of directors
4 things audit committee are responsible for
1 appointment, 2 compensation and 3 oversight of auditors
And 4 audit examination
What do AU 265 and AS 16 require of auditors?
Require auditors to communicate in writing all significant internal
Control deficiencies and material weakness to client
And individuals charged with governance
For public entities AS 16 requires communication to be made prior to…
Audit report release date
What does AU 265 require for non public entities?
Provide communication with those charged with governance
Preferably before audit report release date
But no later than 60 days after audit report release date
If client has not corrected deficiencies or material weaknesses, at end of audit, auditor must…
Communicate them in writing
What do AU 260 and AS 16 require auditors to communicate?
Other significant matters (other than material weakness)
Can be communicated in writing or orally
Management letter
Communication that provides a summary if auditor’s
recommendations resulting from audit engagement
Allows client to improve effectiveness and efficiency of operations
Management letters are not required by GAAS but considered…
An important method of adding value to clients beyond that
Provided by audit examination
From? To? Timing?: Engagement letter
From auditors
To client
Before engagement
From? To? Timing?: Acceptance letter (signed copy of engagement letter)
From client
To auditors
Before engagement
From? To? Timing?: Attorney letter response
From attorney
To auditors
Near date of auditor’s reports
From? To? Timing?: Written representations
From client
To auditor
Date of auditors reports (audit completion date)
From? To? Timing?: Internal control deficiencies
From auditors
To individuals charged with governance
After or during audit
From? To? Timing?: management letter
From auditors
To client
After audit
