Ch5, 6, & 7

Question 1

List the F.S. Assertions for Balance Sheet:

Answer 1

1. The act of handing these F.S. have existence.
2. Have right to those assets & obligations to pay them.
3. Completeness - record using accrual basis.
4. Valuation & Allocation - F.M.V. & cost accounting.

Question 2

List the F.S. Assertions for Income Statement:

Answer 2

1. Occurrence
2. Completeness
3. Accuracy
4. Cut-off Assertion
5. Classification

Question 3

List the F.S. Assertions for Notes (Disclosures):

Answer 3

1. Occurrence
2. Rights & Obligations
3. Completeness
4. Accuracy & Evaluation
5. Classification & Understandability

Question 4

List the 3 types of Risks:

Answer 4

1. Inherent Risk - nature of the business.
2. Control Risk - use of internal control.
3. Detection Risk - finding misstatements.

Question 5

If auditing risk is low,

Answer 5

Then we look at smaller sample size.

Question 6

If auditing risk is high,

Answer 6

Then we need to increase sample size to reduce material misstatements.

Question 7

Auditors only have control over.
A) Inherent risk.
B) Control risk.
C) Detection risk.
D) Risk of material misstatements.

Answer 7

C) Detection risk.

Question 8

What are the 3 types of evidence?

Answer 8

1. Third Party Evidence - best type of evidence
2. Auditors’ Computation - our own calculations.
3. Managements’ Sources - most of our evidence comes from this.

Question 9

Bank Confirmation Request have what 2 sections?

Answer 9

Cash & Loans

Question 10

What is an example of a large & low Potential Response Rate?

Answer 10

Large rate - Accounts receivable.

Small rate - Accounts Payable

Question 11

What is a Specialist? Why do auditors use their service?

Answer 11

A Specialist is someone who is an expert on that particular field that can give monetary value (F.M.V.).
We use specialist to help with gathering evidence which GAAS permits (the auditor is responsible for the specialist!).

Question 12

What do we do if we find Related Party Transactions?

Answer 12

GAAP requires us to disclose in the notes to F.S.

1. Understand the nature of the transaction.
2. There must the an assertion on the sale. Must have adequate disclosure which the transaction is reported in the notes.

Question 13

What is Emphasis of a Matter?

Answer 13

It describes our findings (which may affect user decisions) added to the Opinion Letter. This is based on the auditors’ judgment, which protects us from contingent liability.

Question 14

T/F: A Legal Letter is an asserted claims after 10 days when the Opinion Letter is issued.

Answer 14

False - the Legal Letter have to be dated within 10 days of the Opinion Letter

Question 15

What are the 2 conditions to record Contingent Liability for Asserted Claims?

Answer 15

1. If it is probable (i.e. greater than 50% chance).

2. Must estimate how much court will award.

Question 16

What do auditors do confronting fraud?

Answer 16

As auditors’ we cannot make any legal determination that fraud has occurred. However, it is our job to find indication of fraud.
If we discover fraud, we must bring it to the attention of Audit Committee’s Board of Directors. Then we mention it in Emphasis of a Matter in the Opinion Letter.

Question 17

What points out Financial Distress in a company?

Answer 17

Going Concern Assumption - looks like the company is at financial distress.
Going Concern Issue - when we look for indication of financial distress.

Question 18

Where in the Auditing Standards is Internal Control mentioned?

Answer 18

GAAS -> II. Standards of Fieldwork -> #2. Must obtain a sufficient understanding of internal control as it affects the F.S.

Question 19

T/F: Separation of Duties will result in poor internal control.

Answer 19

False: a good internal control function will have separation of duties.

Question 20

What is Separation of Duties?

Answer 20

1. Authorizing - Department decides what to buy.
2. Recording - the accountant added to inventory.
3. Custody - receiving the physical inventory.

Question 21

To recognize internal control, we must prove:

Answer 21

1. It exists

2. Find the function

Question 22

What opinions can the auditors give if we have Scope Limitations?

Answer 22

Adverse Opinion or Disclaimer

Question 23

What is a Disclaimer?

Answer 23

Opening letter: “We are unable to gather any evidence, thus we cannot issue an opinion.”
This is the worse possible opinion which the auditors’ can give from their results.

Question 24

Describe Reference paragraph.

Answer 24

Opening statement: “We also audited Internal Control & issued this type of opinion of Internal Control.”
This is the last (6th) paragraph in our opinion letter.

Question 25

What is a Loan Covenant? What might they require to give out loans?

Answer 25

Loan Covenant are conditions under which the lunar will lend money to the borrow.
They may ask for Working Capital Requirement such as:
Current Assets must be at 30%.
Current liability ratio at 4:1

Question 26

If a Private company wants to be public what SEC acts do they need to follow?

Answer 26

SEC Act of 1933 - audit 3yrs of Income Statement & 2 yrs of Balance Sheet.

SEC Act of 1934 - to remain a publicly traded company, their F.S. has to be audited every year.