Chapter 16 Flashcards
Auditing Operations
Corporate earnings are considered as an extremely important indicator of health and well-being of corporations.
Measurement of income is generally regarded as the single most important function of accounting.
Conservatism in the Measurement of Income
Powerful influence on revenue and expenses
Important because of subjectivity involved with a accounting estimates.
assets- accountants choose lower of two or more reasonable alternative values.
Liabilities- Higher amount is chosen
- Results in income statement with a low or conservative income figure.
Objectives of Audit of Revenue and Expenses
- use the understanding of the client and its environment to consider inherent risks, including fraud risks, related to revenues and expenses.
- consider internal control over revenues and expenses
- assess the risks of material misstatement of revenues and expenses and design further audit procedures that:
a- establish the occurrence of recorded revenue and expenses transactions
b- determine the completeness of recorded revenue and expenses transactions.
c- establish the accuracy of revenue and expense transactions.
d- Verify the cutoff of revenue and expenses transactions.
e- Determine that the presentation and disclosure of revenue and expense accounts are appropriate, including the proper classification of amounts ad the proper presentation of earnings-per share data.
Miscellaneous Revenue
Auditor should analyze account to look for items improperly recorded as miscellaneous:
- Collections on previously written-off accounts or notes receivables
- Write-offs of old outstanding checks or unclaimed wages.
- proceeds from sales of scrap
- rebates or refunds of insurance premiums
- proceeds from sales of plant assets.
Misc. Revenue- Auditor’s reaction
Propose adjusting journal entry to classify items correctly
Perform analytical procedures and investigate unusual fluctuations
- can detect material amounts of unrecorded revenue
- Significant misclassifications affecting revenue.
Substantive test for selling, General and Administrative Expenses
- Perform analytical procedures
- Obtain or prepare analyses of selected expense accounts
- Obtain or prepare analyses of critical expenses in the income tax return.
Perform analytical procedures
- Develop an expectation of the account balance
- use budgeted amounts, prior-year audited balances, industry averages, relationships among financial data and relevant non financial data.
- Determine the amount of difference from the expectation that can be accepted without investigation.
- Use estimates of materiality
- Compare the company’s account balance with the expected account balances.
- Investigate significant deviations from the expected account balance.
Obtain or prepare analyses of selected expense accounts.
- examine accounts based on results of analytical procedures.
- which accounts? AICPA suggests:
- advertising
- research and development
- legal expenses and other professional fees.
- maintenance and repairs
- rents and royalties.
- Obtain or prepare analyses of critical expenses in the income tax return.
Audit of Statement of Cash Flows
Amounts are audited in conjunction with the audit of balance sheet and income statement accounts.
Presentation and disclosure important audit objective is important
- operating
- Investing
- Financing
Audited Procedures completed Near the End of Field Work
- Search for unrecorded liabilities
- Review the minutes of meetings
- Perform final analytical procedures
- Perform procedures to identify loss contingencies
- perform the review for subsequent events.
- Obtain the representation letter.
Loss Contingencies
Loss contingencies should be reflected in the financial statement amounts when:
- it is probable that a loss had been sustained before the balance sheet date.
- the amount of the loss can be reasonably estimated
Loss contingencies should be disclosed in the notes to the financial statements when it is at least reasonably possible that a loss has been sustained.
Loss contingencies need not be disclosed when the possibility of loss is remote.
Litigation
Most Common loss contingency- pending or threatened litigation.
- letter of inquiry to client’s legal counsel
- evidence of pending and threatened litigation
- unasserted claims- need to be disclosed if probable and reasonably possible.
- SAS 12
- Auditors should obtain from management a list describing and evaluating threatened or pending litigation.
Other Contingencies
- Income tax disputes
- Accommodation endorsements and other guarantees of indebtedness
- Accounts receivable sold or assigned with recourse.
- Environmental issues
- Commitments
- General risk contingencies.
Audit procedures for loss Contingencies
1 - Review the minutes of directors’ meetings to the date of completion of fieldwork.
2 - Send letter of inquiry to client’s lawyer
3 - Send confirmation letters to financial institutions to request information on contingent liabilities of the company.
4 - review correspondence with financial institutions for evidence of accommodation endorsements, guarantees of indebtedness, or sales or assignments of accounts receivable.
5- Review reports and correspondence from regulatory agencies to identify potential assessments or fines.
6- Obtain a representation letter from the client indicating that all liabilities known to officers are recorded or disclosed.
Procedures to Identify subsequent events
- Review latest available financial statements and minutes of the board and selected committees.
- Inquiry about matters dealt with at meetings for which minutes are not available.
- Inquiry of management
- Obtain lawyer’s letter.
- Obtain representations from management.
Obtain Representation Letter
Purpose is to have the client’s principal officers acknowledge that they are primarily responsible for the fairness of the financial statements.
Dated as the date of the audit report
Not a sunstitute for application of necessary audit procedures.
Misstatements
Known misstatements
- specific misstatements identified during the course of the audit.
Likely misstatements
- Due to extrapolation from auto evidence or differences in accounting estimates.
Evaluation
- Material misstatements must be corrected
- Quantitative and qualitative factors.
Qualitative Materiality Factors
Likely to be material when:
- Arise form an item capable of precise measurement rather than from an estimate.
- 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 regulator 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.
Review the Engagement
- Review of work of audit staff accomplished through review of audit working papers.
- typically performed by seniors.
- review of working papers not completed until near (of after) completion of fieldwork.
- partner and manager vote attention to accounts with higher risk of material misstatement.
- Second partner review prior to issuance of audit report.
Significant Findings from the audit.
- Qualitative aspects of accounting practices
- audit difficulties encountered
- uncorrected misstatements
- disagreements with management
- management consultations with other accountants
- auditor independence issues.
- Other issues.
Post-Audit Responsibilities
Auditor subsequent discovery of facts existing at date of report.
- 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.
Subsequent discovery of Omitted audit Procedures.
Discovered during peer review or other subsequent review of working papers.
Assess importance of omitted procedures to their previously issued opinion
- 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.
