Chapter 18 Flashcards
Auditors of public companies should report on what two things?
Financial statements and
Internal control over financial reporting (ICOFR), according to PCAOB No. 5 - the audits of internal control and financial reporting should be viewed as integrated
Based on section 404a, all public companies need to:
To include an internal control report when filing its annual report (10-K) with SEC. In this, Management acknowledges responsibility for establishing and maintaining adequate internal control. It also provides an assessment of internal control effectiveness at end of fiscal year, while increasing management’s responsibility for demonstrating that controls are effective
Management’s Responsibility for Internal Control under SOX is listed as the following (describe one)
- Accept responsibility for effectiveness of ICOFR
- Evaluate the effectiveness using suitable criteria
- Support the evaluation with sufficient evidence
- Provide a report on internal control
Which section of Sarbanes Oxley, 404a or 404b, requires auditors of public companies with market capitalization in excess of $75,000,000 to audit internal control and express an opinion on effectiveness of internal control
404b
Flip card to see SEC’s definition of ICOFR
Internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and affected by the company’s board of directors, management, and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
What is the Auditor;s Objective when it comes to ICOFR?
Plan and perform the audit to obtain reasonable assurance about whether material weaknesses exist to express an opinion on effectiveness of company’s ICOFR. No material weakness = effective ICOFR. One or more material weaknesses = ineffective ICOFR
.
What is the Objective of Management’s Evaluation of ICOFR?
To provide a reasonable basis for its annual assessment as to whether there are any material weaknesses in ICOFR as of year-end
What is a Control Deficiency?
design/operation of control does not allow timely prevention/detection of misstatements
See slide 8 for levels of control deficiencies
Slide 8
Management Assessment of ICOFR includes the following:
- Process of identifying significant controls and testing their design and operating effectiveness
- Management can be assisted by consultants but not by the audit firm conducting financial statement audit
- Evaluation must use an accepted “control framework” such as Internal Control-Integrated Framework created by COSO
- Must understand concepts of control deficiency, significant deficiency, and material weakness
- Must understand SEC’s definition of internal control
The report on ICOFR does what? (Name one of the four following)
- State that it is management’s responsibility to establish and maintain adequate internal control
- Identify management’s framework for evaluating internal control
- Include management’s assessment of the effectiveness of the company’s internal control over financial reporting as of the end of the most recent fiscal period, including a statement as to whether internal control over financial reporting is effective
- Include a statement that the company’s auditors have issued an attestation report on management’s assessment
What are steps for auditing internl control?
- Plan the engagement
- Use a top-down approach to identify controls to test
- Test and evaluate design effectiveness of internal control
- Test and evaluate operating effectiveness of internal control
- Form an opinion on the effectiveness of internal control
Explain Planning the Engagmeent - the first step
Efficient planning requires coordination with financial statement audit.
Initial knowledge of ICOFR during planning will vary based on nature of client and experience with client. New auditor – little knowledge/much work on understanding ICOFR for planning. have much knowledge and just need to update this knowledge for planning
Auditors should use a top-down approach to identify controls to test. Further elaborate this 2nd step
Starts at the top with financial statement elements and entity-level controls.
Links these to significant accounts, relevant assertions, and major classes of transactions. The goal is to focus on testing most important controls. See slide 16
Define Entity-Level Controls
Controls with a pervasive effect on internal control system (as opposed to controls for specific objectives). Often those in control environment or monitoring components of internal control, for example:
- Tone at the top
- Assignment of authority/responsibility
- Corporate code of conduct
PCAOB Standard No. 5 emphasizes controls relating to what? (Name one of the three)
- Audit committee effectiveness
- Fraud
- Period-end reporting process (“financial statement close”)
Account is considered “significant” if
reasonable possibility that it could contain a misstatement that has a material effect on financial statements (does not consider internal control effectiveness). Auditor should obtain understanding of significant accounts and disclosures
See slide 18 for antifraud programs
slide 18
Do redundant controls need to be tested?
No.
Redundant controls – those that duplicate other controls (do not need to test if duplicate control is tested)
Accounting estimates - involve management’s judgments or assumptions (e.g., determining the allowance for doubtful accounts, estimating warranty reserves, assessing assets for impairment). True or false?
True
Once determinec significant accounts and disclosures, auditor must determine which of the assertions are relevant:
(1) existence or occurrence;
(2) completeness;
(3) valuation or allocation;
(4) rights and obligations; and/or
(5) presentation and disclosure.
Relevant assertions are those that have meaningful bearing on whether account is presented fairly (e.g., valuation may be very relevant to accounts receivable but not for cash)
Name one of the factors to determine significance of account:
- Size and composition.
- Susceptibility of loss due to errors or fraud.
- Volume of activity, complexity, and homogeneity of individual transactions.
- Nature of the account.
- Accounting and reporting complexity.
- Exposure to losses.
- Possibility of significant contingent liabilities.
- Existence of related party transactions.
- Changes from the prior period.
What are complementary controls?
work together to achieve particular control objective (both should be tested)
difference betwen preventive and detective controls
preventive – prevent error/fraud from occurring
Detective – detect errors or fraud that has already occurred
Auditor generally tests combination of both for relevant assertions
Tracing a transaction from its origination through the company’s information system until it is reflected in the company’s financial reports in known as a
Walk-Through. Frequently the most effective way to obtain an understanding of classes of transactions and likely sources of misstatement
