Chapter 16 Flashcards
Corporate earnings are considered as an extremely important indicator of health and well-being of corporations - true or false?
True
Name one of the three objectives for Audit of Revenues and Expenses
- Use the udnerstanding of the client and environment to consider the inherent risks - including fraud risks - related to revenues and expenses
- Consider internal control over revenues and expenses (control risks)
- Assess the risk of material misstatement of revenues and expenses and design further audit procedures
The single most important function of accounting is measurement of stockholder’s equity
False - Measurement of income is generally regarded as the single most important function of accounting
When applying conservatism on the measurement of income, the (higher/lower) amount of liabilities or expenses is chosen
Higher - we do not want to UNDERSTATE
Conservative results in income generally should result with a higher income figure - True or false?
False -
Results in income statement with a low or conservative income figure
See slide 5 for relationships between balance sheet and income statement accounts
slide 5
When applying conservatism on the measurement of income, the (higher/lower) amount of assets/revenues chosen
Lower - Do not want to OVERSTATE
Give an example of designing further audit procedures (the third objective of auditing revenues and expenses)
a. Establish the OCCURRENCE of recorded revenue and expense transactions.
b. Determine the COMPLETENESS of recorded revenue and expense transactions.
c. Establish the ACCURACY of revenue and expense transactions.
d. Verify the CUTOFF of revenue and expense transactions.
e. Determine that the PRESENTATION AND DISCLOSURE of revenue and expense accounts are appropriate
Define miscellaneous revenue
Mixture of minor items - some are nonrecurring and some are received at regular intervals.
Auditors should:
- Analyze account to look for items improperly recorded as miscellaneous
- Propose adjusting journal entries to classify items correctly
-Perform analytical procedures and investigate unusual fluctuations, which
can detect material amounts of unrecorded revenue and
significant misclassifications affecting revenue
Revenue accounts are frequently verified in conjunction with their related balance sheet accounts. Give one example
(Revenue account - Balance sheet Item)
Sales - Accounts Receivable
Notes Receivable - Interest
Securities - Interest/dividends/gain on sales or shares
PPE - rent, gains on sale
Intangible assets - Royalties
Substantive Tests for Selling, General and Administrative Expenses include analytical procedures such as: (name one)
- Develop an EXPECTATION of the account balance
- Determine amount of DIFFERENCE from expectation that can be accepted without investigation. (Materiality)
- COMPARE account balance with expected account balance
- Investigate SIGNIFICANT DEVIATIONS from the expected account balnace
Expenses accounts are also frequently assoc. with balance sheet accounts. Give one example
See picture on slide 9
Name one reason payroll fraud is now more difficult to conceal compared to when it was much more common?
- Extensive segregation of duties
- Use of computers with proper controls for preparation payments
- Filing of frequent payroll reports to the government
Typically the largest operating cost is Cost of Goods Sold
False - It’s Payroll.
The first step in the audit program for payroll is typically to perform TEST OF CONTROLS over PAYROLL TRANSACTIONS for selected pay periods. Name one of the specific proceudres
a. Compare names and wage or salary rates to records maintained by the human resources department.
b. Compare time shown on payroll to time cards and time reports approved by supervisors.
c. If payroll is based on piecework rates rather than hourly rates, reconcile earnings with production records.
d. Determine basis of deductions from payroll and compare with records of deductions authorized by employees.
e. Test
extensions and footings of payroll.
f. Compare total of payroll with total of payroll checks issued.
g. Compare total of payroll with total of labor cost summary prepared by cost accounting department.
h. If wages are paid in cash, compare receipts obtained from employees with payroll records.
i. If wages are paid by check, compare paid checks with payroll and compare endorsements to signatures on withholding tax exemption certificates.
j. If wages are paid by direct deposit, compare listing of employee payments with payroll and direct deposit authorizations.
k. Observe the use of time clocks by employees reporting for work and investigate time cards not used.
Which accounts do the AICPA suggest to examine when conducting analytical procedures on selected expense accounts
- SG&A Expenses
- Advertising
- Legal expenses and other professional fees
- Maintenance and repairs
- Rents and royalties
These are typically suggested since they are often, or recurring payments. If they look similar to last year, they should be ok.
The second step in the audit program for payroll is to
Perform substantive tests over PAYROLL TRANSACTIONS. See picture from slide 15
True or False - Cash Flows statement require vast amounts of substantive testing
False - Little substantive testing is necessary. Amounts are audited in CONJUNCTION with the audit of balance sheet and income statement accounts. Cash flow amounts are reconciled with audited balances from other financial statements. The most work on the cash flows will be on it’s PRESENTATION AND DISCLOSURE - it’s particularly important to correctly classify cash flows between operating, investing, and financing
Name an audit proceudre completed near the end of field work
- Search for unrecorded liabilities (examining cash disbursements subsequent to, or after, year end)
- Review minutes of sticjholders and directors through date of audit report (including subsequent to year end)
- Perform final analytical procedures, such as consideration of previously undidentified fraud risk, which auditng standards require. Also may identify other areas to examine further.
- Perform procedures to identify loss contingencies
- Perform review for subsequent events
- 0btain the representation letter
See slide 18 for audit procedures for contingencies
Slide 18
See slide 19 for more audit procedures for contingencies
Slide 19
A legal confirmation letter requested from the client’s attorneys include a list including:
(1) pending threatened litigation
and (2) asserted or unasserted claims or
assessments with which the attorney has had
involvement. Also a request that the attorney comment about the
progress of each item, including assessed
probability and estimatability of loss.
ALSO inclides:
- Reuqest of the law firm to identify any unlisted pending or threatened legal actions. If none occur, a statement that client’s list is complete would be nice.
- Statement informing attorney of the ATTORNEY’S RESPONSIBILITY to inform management of legal matters that would require disclosure in financial statements. They should directly respond to the auditor
Congress included provisions in this act directing
the SEC to issue rules requiring attorneys serving
public companies to report material violations
by the company of federal securities laws.
Sarbanes-Oxley Act
If an attorney refuses to provide the auditor with information about material existing lawsuits or unasserted claims,
auditors must modify their audit report to reflect the lack of available evidence.
See slide 24 for picture (and maybe book)
slide 24
Other contingencies include (name one. Hint for one of them: Business Ethics Chapter 12)
- Income tax disputes
- Accommodation endorsements and other guarantees of indebtedness
- Accounts receivable sold or assigned with recourse
- Environmental issues (increasingly common )
- Commitments
- General risk contingencies
Further define a Type 1 Subsequent event
provide additional evidence to CONDITIONS THAT EXISTED AS OF BALANCE SHEET DATE
- Requires ADJUSTMENT of financials if evicence supports doing so
If a client is committing a crime or fraud, an attorney can’t report it due to a breach in confidentiality. True or False?
False - The American Bar Association amended its
attorney-client confidentiality rules to permit
attorneys to breach confidentiality if a client
is committing a crime or fraud.
A type 2 subsequent event is defined as
involving CONDITIONS COMING INTO EXISTENCE AFTER BALANCE SHEET DATE. Does not require adjustment of financials, but does require a disclosure if they are significant.
Examples include loss from fire/natural disaster, major bond/equity issuance, or a merger/acquisition.
When subsequent events are focued on, what are the audit tests like?
- Inquiry of Management
- Correspondance with attorneys
- Reviewing internal statements prepared after balance sheet date
- Review records prepared subsequent to balance sheet date
- Esamine minutes issued subsequent to balance sheet
- Obtiain a letter of representation - a mandatory letter.
If there’s a loss from a fire after the balance sheet date, which type of event is this? Type 1 or Type 2?
Type 2 - conditions coming into existence after balance sheet date. Does not require adjustment of financials but does require disclosure if are significant
When is Dual Dating necessary?
Dual dating is necessary is a subsequent event comes to the auditor’s attention after the audit report date but before the client issues the report. Proper discloure occurs by
- Extending all audit responsibilities through a changed later audit report date
- Dual dating
- First date is the date for the compeltion of field work except for a specific exception
- Second date, which is always later, deals with the exception
Auditing standards suggest which four categories of specific matters in the management representation letter?
- Responsibility for financial statements
- Completeness of information
- Recognition, measurement, and disclosure
- Recording and disclosing subsequent events
The purpose of obtaining a management representation letter is to
have the clinet’s principal officers acknowledge that they are primarily responsible for FAIRNESS of financial statements
What isthe date of the management representation letter?
Dated as of the date of the audit report
Flip for an example of a Dual date
Example: An auditor returned to the client’s premises to perform audit tests pertaining only to the acquisition and completes those tests on March 31. The audit report will be dual-dated as follows: March 11, 2014, except for note 17, which is dated March 31, 2014.
Known misstatements are
Specific misstatements identified during the course of the audit (auditor determines exact amount of misstatement to require adjustment)
Likely misstatements are
Likely misstatement identified during the course of the audit due to:
Projecting findings from audit sampling on account population, or
Differences between auditor and management judgment on accounting estimates
What goes on during the completion phase?
Auditors evaluate evidence accumulated to determine if any additional presentation and disclosure testing is necessary
Should uncorrected misstatement from prior year be included in this year’s materiality calculations?
If material to current year’s audit, prior year’s financials (including retained earnings) should be adjusted and restated.
If immaterial to current year’s audit, may be adjusted in the current year instead of restating prior year financials.c
See slide 35 for examples of Disclosure Tests
slide 35
Engagement work is typically reviewed by lower-level management
False - Typically performed by seniors. Accomplished through review of audit working papers. Not completed until near (or after) completion of fieldwork.
Something is likely to be material when:
- Arise from an item capable of precise measurement (e.g., the amount of a sale) rather than from an estimate (e.g., the amount in the allowance for doubtful accounts).
- Mask a change in earnings or other trends.
- Hide a failure to meet analysts’ consensus expectations for the company.
- Change a loss into income, or vice versa.
- Concern a particularly important segment or other portion of the registrant’s business.
-Affect compliance with regulatory requirements, loan covenants, or other contractual requirements.
Increase management’s compensation.
-Involve concealment of an unlawful transaction.
Are of an amount that management or the auditors believe would affect the stock’s price.
Subsequent Discovery of Omitted Audit Procedures are typically discovered during
peer review or other subsequent review of working papers
If omission impairs ability to support issued opinion and report being relied upon by third parties, attempt to perform omitted procedure or appropriate alternative procedure. True or False?
true. Assess importance of omitted procedures to their previously issued opinion
If a discovery of facts occurs subseqently tht existed at the date of the report, one should
Advise client to make appropriate disclosure of the facts to anyone actually or likely to be relying upon the audit report and financial statements. If client refuses to make disclosure, CPA should inform each member of board and notify regulatory agencies
This is an example of what?
“6.
During the year under audit, we were advised that management consulted with Gonzales & Ramirez, CPAs. The purpose of this consultation was to obtain another CPA firm’s opinion concerning the company’s recognition of certain revenue that we believe should be deferred to future periods. Gonzales & Ramirez’s opinion was consistent with our opinion, so management did not recognize the revenue in the current year.”
Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).
What is this an exaple of - “As discussed in Note 4 to the financial statements, the company experienced a net loss for the year ended July 31, 2013, and is currently in default under substantially all of its debt agreements. In addition, on September 25, 2013, the company filed a prenegotiated voluntary petition for relief under Chapter 11 of the U.S. Bankruptcy Code. These matters raise substantial doubt about the company’s ability to continue as a going concern.”
Explanatory paragraph of an auditor’s report on financial statements.
What would this come from - “It is our opinion that the possible liability to the company in this proceeding is nominal in amount.”
Lawyer’s response to audit inquiry letter.
”
There have been no communications from regulatory agencies concerning noncompliance with or deficiencies in financial reporting practices.” This would be on the
Management representation letter.
The company considers the decline in value of equity securities classified as available-for-sale to be temporary. This would be on
Management representation letter.
“The company believes that all material expenditures that have been deferred to future periods will be recoverable.”
Management representation letter.
Example of
Auditor’s communications on significant deficiencies and material weakness.
During our audit we discovered evidence of the company’s failure to safeguard inventory from loss, damage, and misappropriation.
“Indicate in the space provided below whether this information agrees with your records. If there are exceptions, please provide any information that will assist the auditor in reconciling the difference.”
Accounts receivable confirmation request.
Auditor’s communications on significant deficiencies and material weakness may look like
Blank checks are maintained in an unlocked cabinet along with the check-signing machine. Blank checks and the check-signing machine should be locked in separate locations to prevent the embezzlement of funds.
“Our use of professional judgment and the assessment of audit risk and materiality for the purpose of our audit mean that matters may have existed that would have been assessed differently by you. We make no representation as to the sufficiency or appropriateness of the information in our working papers for your purposes.”
Predecessor auditor’s communication with successor auditor.
The company has no plans or intentions that may materially affect the carrying value or classification of assets and liabilities.
Management representation letter.
“Several employees have disabled the antivirus detection software on their PCs because the software slows the processing of data and occasionally rings false alarms. The company should obtain antivirus software that runs continuously at all system entry points and that cannot be disabled by unauthorized personnel.”
Auditor’s communications on significant deficiencies and material weakness.
“The company has insufficient expertise and controls over the selection and application of accounting policies that are in conformity with GAAP.
Auditor’s communications on significant deficiencies and material weakness
“The timetable set by management to complete our audit was unreasonable considering the failure of the company’s personnel to complete schedules on a timely basis and delays in providing necessary information.”
F.
Auditor’s communication to those charged with governance (other than with respect to significant deficiencies and material weakness).
“In planning the sampling application, was appropriate consideration given to the relationship of the sample to the assertion and to planning materiality?”
PArtner’s review notes
Type 2 subsequent events come into existence _____ the balance sheet date
after
Type 1 subsequent events require the financial statements to be _______ if needed.
adjusted
Tests of revenue and expenses often involve analytical procedures.
True
Subsequent events need to be disclosed in the financial statements; otherwise, the financial statements would be
misleading
The auditors perform an analysis of professional fees in part to determine that they have considered obtaining a lawyer’s letter from all attorneys that are handling litigation for the client. True or False?
True
Making payroll expenditures from an imprest payroll bank account ordinarily is a strength relating to internal control, rather than a weakness.
True
For effective internal control over payroll, the personnel department should prepare the payroll records and checks.
False.
The payroll department of a company should notsign and distribute company paychecks.
The auditors generally perform an analysis of the miscellaneous revenue account to determine the nature of the items recorded to the account. True or false
true
CPAs have no responsibility to perform audit procedures after the date of their report but must still investigate events that are brought to their attention and might have affected their report.. True or false?
true
Disclosure checklists are used to test the completeness of audit working papers.. True or false?
false
True or false:
The representations letter from management should be dated and signed on the balance sheet date.
False
For which of the ledger accounts would the auditor be most likely to analyze the details?
miscleanneous
Dual–dating of an audit report occurs when the auditors are not able to complete an audit engagement as of a particular date and must return to complete the audit work on a later date. - true or false
false - first date is the date for the compeltion of field work except for a specific exception
- Second date, which is always later, deals with the exception
The date of the management representation letter should coincide with the:
date of auditor’s report
A surprise observation by an auditor of a client’s regular distribution of paychecks is primarily designed to satisfy the auditor that:
names on the company payroll are those of bona fide employees presently on the job.
Auditors perform interim work at various times throughout the year. The auditors’ subsequent events work should be extended to the date of:
auditor’s report
T or F: The duties of hiring, payroll computation, and payment to employees should be segregated.
True. Proper internal control over apyroll
A client has a calendar year–end. Listed below are four events that occurred after December 31. Which one of these subsequent events is most likely to result in adjustment of the December 31 financial statements?
A substantial portion of the company’s inventory was written off as obsolete on January 31.
The client decided to change depreciation methods in the coming year.
