Evidence and Risk

Question 1

Definition of Audit Evidence

Answer 1

AU-C 500 - Audit Evidence consists of all information used by the auditor in arriving at the conclusions on which the audit opinion is based.

It includes the information contained in the *accounting records *underlying the financial statement (checks, invoice, contract) and other information (minutes, confirmations, benchmarking).

Accounting records alone is not sufficient appropriate evidence.

Question 2

What is the relationship between Evidence and Detection Risk?

Answer 2

• Evidence has an inverse relationship with Detection Risk
• The Detection Risk is one aspect of Audit Risk that an auditor can control through Nature Timing Extent of substantive procedures
• Inherent Risk and Control risk are outside of auditor’s control

Question 3

Which aspects of Audit Risk can an auditor control?

Answer 3

Detection Risk which is decreased by increasing substantive procedures

Question 4

What is the primary constraint on audit evidence?

Answer 4

Cost vs. Benefit is a primary constraint

Question 5

Which aspects of Audit Risk can an auditor NOT control?

Answer 5

Inherent Risk and Control Risk are outside of an auditor’s control

Question 6

High level of Detection Risk

Answer 6

• Scope of substantive procedure → lower
• Nature → less reliable audit evidence
• Timing → gather audit evidence prior to year-end (interim)
• Extent → verify a smaller number of transactions or components of the account balance

Question 7

Low level of Detection Risk

Answer 7

• Scope of substantive procedure → Higher
• Nature → More reliable audit evidence (often externally generated)
• Timing → perform test at year end
• Extent → verify a larger number of transactions or components of the account balance

Question 8

What characteristics should audit evidence have?

Answer 8

Sufficient → **Quantity of evidence

• Persuasive evidence, not totally convincing evidence
• cost vs. benefit of obtaining the evidence
• based on the auditor’s judgment

Appropriate → Quality of evidence

• Relevant: pertains to the assertion it support
• Reliable: based on the source (+ directly obtain, obtained from outsider, prepared by outsider, prepared by client -), personal knowledge, or developed under strong IC
• based on the auditor’s judgment

Question 9

Persuasiveness of evidence based on its source

Answer 9

More to Less Persuasive

1. Auditor developed - directly obtained by auditor (e.g. inventory observation) - More persuasive
2. Outside – obtained from source outside of the client company (e.g. bank confirmation)
3. Outside/Inside – prepared by outsider but obtained from client (e.g. bank statement)
4. Inside – prepared by client (e.g. client sale invoice)

Question 10

Basic procedures used in Audit

Answer 10

• Risk Assessment procedure – used to obtain an understanding of the entity and its environment, including Internal Control (Chap 1). They do not provide a sufficient basis for auditor opinion - PLANING
• **Test of Controls **are performed to test the operating effectiveness of controls in preventing or detecting material misstatement at the relevant assertion level (chap 4)
• Substantive procedures – used to detect material misstatement ​ through test of details and analytical procedures for all relevant assertion related to each material class of transaction, account balances, and disclosures. These are used regardless of the assessed risk of material misstatement. (chap 5)

Question 11

What are the objectives when evaluating an entity’s accounting estimates?

Answer 11

AU-C 540 When evaluating accounting estimates an auditor’s objectives are to obtain sufficient appropriate evidence that (1) all material accounting estimates have been developed, (2) are reasonable, and (3) are in conformity with GAAP.

Question 12

How are Management Estimates audited?

Answer 12

• First and foremost you need to understand management’s rationale and methods for developing estimates before you can judge reasonableness.
• Next Auditor should formulate their own opinion on what a good estimate should be and compare it.
• Finally determine if subsequent events affect the estimates

Responsibility of the auditor with respect to estimates is to evaluate the reasonableness of accounting estimates in the context of the financial statements taken as a whole

Question 13

What are Substantive Procedures?

Answer 13

• Substantive procedure is an audit procedure designed to detect material misstatement at the assertion level.
• Substantive procedure comprise Test of Details (of transaction, balances, and disclosures) and Analytical Procedures.
• Types of procedures **I-CORRII A **

Question 14

Test of Details of transaction, balances, and disclosures TD

Answer 14

Test of details refer to test designed to verify the account balances, the transactions and the disclosures that occurred during the year and were the source of the account balances.

I-CORRII (Analytical procedures)

TD includes:* Inquiries, ** **_C_onfirmation, Observation, Recalculation, Reperformance, Inspection of tangible asset,* Inspection/Examination of records or document (Tracing, Vouching)

Question 15

Tracing and Vouching

Answer 15

ICORRII - A

Inspection/Examination of records or documentation

Tracing → Completeness: trace from the source of the document into the book -understatement

Vouching → Existence or Occurrence: book to source - overstatement

Question 16

How do Analytical Procedures assist the auditor?

Answer 16

• AP provide evidence as to the reasonableness of management’s assertions
• AP involve comparing information in the financial statement to evaluate the relationships
• AP may involve financial and nonfinancial data
• AP use *ratio analysis *

Question 17

When Analytical Procedures may be performed during an audit?

Answer 17

AP may be performed at 3 different times during an audit:

Risk assessment/ in planning the audit – focus on enhancing the auditor’s understanding of the client’s business and events that have occurred since the last audit date, and on identifying areas that may represent specific risks relevant to the audit → Required

Substantive procedure - used to obtain relevant and reliable audit evidence to substantiate accounts for which overall comparisons are helpful → Optional

Near the end of audit – used to assess conclusions reached and evaluate overall financial statement presentation - performed by manager or partner with overall knowledge of the client business and industry → Required

NOTE GAAS requires the use of analytical procedures during the risk assessment and near the end of the audit. Analytical procedures are not a required substantive test.

Question 18

5 basic types of comparison that may be performed as AP

Answer 18

CRAFT

• *Client vs. Industry *
• Related Accounts
• Actual vs. Budget
• Financial vs. Non-Financial
• *This year vs. Prior *

More predictable relationship **AU-C 520 **

• Income statement than BS for AP
• not subject to management discretion

Question 19

How is the Current Ratio calculated?

Answer 19

Current Ratio = Current Assets / Current Liabilities

Liquidity ratio measures short-term debt-paying ability

Question 20

How is the Quick or Acid test Ratio calculated?

Answer 20

Quick Ratio = Liquid Assets / Current Liabilities

Liquid Assets = Cash, cash equivalent + Marketable securities (current investment) + Net Account receivable (does not include inventory)

Liquidity ratio measures short-term liquidity

Question 21

How is the Asset Turnover calculated?

Answer 21

Asset Turnover = Net Sales / Average Assets

Activity Ratio measures how efficiently assets are used to generates sales

Question 22

How is the Inventory Turnover calculated?

Answer 22

Inventory Turnover = COGS / Average Inventory

Acitivity Ratio *measures the liquidity of inventory *

inventory turnover analysis may be useful to the auditor in detecting the existence of obsolete merchandise

Question 23

Receivables turnover

Answer 23

Receivable turnover = Net credit sales / Average net accounts receivable

Acitivity Ratio measures the liquidity of receivables

Question 24

How is **Gross Margin ** calculated?

Answer 24

Gross Margin = Net Income / Net Sales

Profitability ratio *measures net income generated by each dollar of sales *

Question 25

Debt to equity ratio

Answer 25

Debt to equity = Total debt / stockholders’ equity

Coverages ratio shows creditors the corporation’s ability to sustain losses

Question 26

Gross Profit ratio

Answer 26

= Gross profit or (sale- COGS) / Net Sale

Question 27

How do management assertions affect the audit?

Answer 27

• Assertions are representations by management, explicit or otherwise, *that are embodied in the financial statement, as used by auditor to consider the different types of potential misstatements that may occur. *
• Management assertions help the auditor to plan the audit and select substantive tests.

Question 28

What assertions do auditors test?

U-PERCV

Answer 28

U-PERCV

AU-C 500

• Understandability & Classification
• Presentation & Disclosure
• Existence/Occurrence - Did it happen? Does it exist?
• Rights & Obligations - Does the company own them?
• Completeness & Cutoff - Was everything recorded? Is it in the right period and category?
• Valuation, Allocation & Accuracy - Are they worth the amount at which they are recorded?

Question 29

**11 Management Assertions **

COCA-CURVE

Answer 29

COCA-CURVE

• Completeness
• Occurrence
• Cutoff
• Accuracy
• Classification
• Understandability
• Rights & Obligations
• Valuation & Allocation
• Existence

NOTE No Presentation & Disclosure

Question 30

11 Management Assertions are groupe in ** 3 Categories **

Answer 30

3 Categories

• Transaction Classes & Events
  
  • CPA CO
• Account Balance – at year end
  
  • RACE
• Presentation & Disclosures
  
  • RACU

Question 31

Transaction Classes & Events

CPA CO

Answer 31

CPA CO

• Completeness
• Period Cutoff
• Accuracy
• Classification
• Occurrence

Question 32

Account Balance – at year end

RACE

Answer 32

RACE

• Rights & Obligations
• Allocation & Valuation
• Completeness
• Existence

Question 33

Presentation & Disclosures

RACU

Answer 33

RACU

• Rights & Obligations
• Accuracy & Valluation
• Completeness
• Understandability

Question 34

Audit Program

Answer 34

• Audit program is a detailed list of the audit procedures to be performed in the course of an audit.
• Financial statement → Assertions → Audit Objectives → Audit Procedure → Audit Program

Question 35

2 approaches for auditing an account

Answer 35

• Test of Balance: direct test the ending balance - many transactions, small dollar amounts, high turnover (cash, A/R, Inv, A/P)
• Test of Transaction: test input and output during the year - *few transactions, large dollar amounts, low turnover *(investment, PP&E, Bonds, N/P, stockholder equity)

Question 36

Audit Objective

Answer 36

The auditor develops specific audit objectives in order to substantiate assertions that are material to the financial statement.

Question 37

Whose property are audit documentation (audit workpapers)? In what form must they be?

Answer 37

• Audit workpapers are the property of the auditor
• They can be paper or electronic
• **AU-C300 **They must include a WRITTEN audit program (either paper or electronic)
• objectives of documentation is to provie sufficient and appropriate record of the basis and that the audit was planned and performed in accordance with GAAS

Question 38

What is the Current File?

Answer 38

• Corrobating Information pertaining to the current year’s audit
• Example: Audit program, working trial balance, lead schedules, response to information requests, reconciliations and analysis by the auditor,Bank reconciliation

Question 39

What is the Permanent File?

Answer 39

• contian Information used for this audit and future audits which is updated as needed
• Examples: Organization documents, Minutes, Flowcharts of the internal control structure, Debt agreements, Analyses of equity accounts, Depreciation schedules

Question 40

How long must audit workpapers be maintained?

Answer 40

• Must be kept for 5 years after the audit release date or according to regulations whichever is longer AU-C 230
• Must be kept for 7 years or period required by law under PCAOB Audit Standard 3 AS3 - for audit of public companies reporting to SEC
• PCAOB AS3 audits also require an Engagement Completion Document

Question 41

What is the primary requirement for audit workpapers besides being written?

Answer 41

• Any experienced auditor having no prior connection with the engagement should be able to look at your work and understand what you did
• The workpapers must contain support for the auditor’s conclusions concerning significant aspects of the examination

Question 42

How should documents added to work papers be treated?

Answer 42

If further documents are added to the work papers after the audit report is issued it must be documented as to who added them why they were added and any effects on the audit report

Question 43

Documents completion period

Answer 43

• After the audit report is released the firm has 60 days to subtract from the file. You can still add to the file if you document it but you cannot delete any information after 60 days.
• AS3 - for SEC auditors the PCAOB only allows deletions up to 45 days after issuance of the audit report

Question 44

Kitting

Answer 44

• Kitting is an form a fraud by the client to *overstate the total cash in bank *by reporting a receipt in the current period without reporting the equivalent disbursement
• Kitting occurs *when the disbursement per books occurred after year end but the receipt occurred before year-end *
• is best detected through the use of a bank transfer schedule

Question 45

Documents for Cash

Answer 45

• Bank transfer schedule – primary purpose is to help auditors to detect kitting
• Bank reconciliation – allow the auditors to reconcile balance per bank to the book
• Bank cutoff statement – primary purpose is to help auditor to verify reconciling item on the year end bank reconciliation – verify outstanding check and deposit in transit have been cleared – sent directly from the bank to the auditor
• Bank Confirmation/ standard confirmation form– to obtain information from the bank on deposit and loan balance and collateral agreement on loans – sent at the request of the client directly to the auditor

Question 46

Typical Substantive audit procedures for cash - PERCV

Answer 46

** Presentation & Disclosure**

• review and disclosures for compliance with GAAP
• Inquire about compensating balance requirements and restrictions

**Existence/Occurrence **

• confirmation
• count cash on hand
• prepare bank transfer schedule (kitting)

**Rights & Obligations **

• review bank Statements

**Completeness & Cutoff **

• review cutoff (receipts and disbursements)
• perform AP
• obtain bank cutoff statement to verify reconciling items on bank reconciliation

**Valuation, Allocation & Accuracy **

• foot summary schedules
• reconcile summary schedule to the ledger
• test translation of any foreign currencies

Question 47

Deposit in Transit

Answer 47

• Deposit in Transit occurs when the disbursement per books occurred before year end but the receipt occurred after year-end
• Understament of the total cash

Question 48

Lapping of A/R

Answer 48

Attempt to cover theft of receivables collection by posting subsequent collection from another customer to that subsidiary account

Question 49

Tests to ensure that No lapping of A/R

Answer 49

Best way to control lapping is Segregation of duties

Lapping can be detected by using the following procedures:

• Analytical Procedure - age of receivable and turnover ratio
• Confirm receivable
• Deposit slips: suprise inspection
• Bookkeeping systems: Foot cash reciept journal
• Comparison of the dates on the check deposit to the bank with the posting dates in the receivable records

Question 50

Existence, Valuation, and Completness assertion of AR

Answer 50

• Existence: receivable confirmation primarily test the existence assertion of the receivable - Confirmation is a generally accepted auditing procedure
• Valuation: subsequent collection, aging of receivable, examination of credit rating of customer
• Completeness: perform cutoff test, tracing of shipping documents to sales invoices, examination of numerical sequences of shipping documents and sale invoices

Question 51

3 types of confirmation

Answer 51

1) Negative confirmation

• No need to response
• Customer only responds if balance is materially wrong
• Used when small balance and if reliance ↑ RRM (CR + IR) ↓ DR↑ AU-C 505
• No response - customer agree with the amount

2) Positive confirmation

• Customer need to confirm the correctness of amount
• Used when large balance and if reliance ↓ RRM (CR + IR) ↑ DR

3) Blanc confirmation

• Customer need to provide the amount without being told value on client records
• Used when large balance and if reliance ↓ RRM (CR + IR) ↑ DR ↓

NOTE

When using confirmations the auditor should consider

a. Prior experience—response rates, misstatements identified, and inaccurate replies
b. Nature of information being confirmed—consider whether respondents may reply effectively and understand the information being confirmed
c. Appropriate respondent—consider who should receive the confirmation request so as to help assure a meaningful response

Question 52

Procedures when customer does not respond to positive or blank confirmation

Answer 52

• Send 2nd confirmation
• Ask client to contact customer and request response
• Alternative procedures:

• Review cash receipts in subsequent period
  - Inspect shipping document
  - examine customer correspondence with client
  - consider Audi adjustment
• However, the auditor may consider not performing alternative procedures when (a) no unusual qualitative factors or systematic characteristics related to responses have been identified, and (b) the nonresponses in total, when projected as 100% misstatements to the population, are immaterial.

Question 53

Typical Substantive audit procedures for A/R

Answer 53

Presentation & Disclosure

• Review and disclosures for compliance with GAAP
• Inquire about pledging and discount
• Review loan agreement for pledging, factoring

E*xistence/Occurrence *

• Confirmation
• Inspect notes
• Vouch ( examine shipping documents, invoices, credit memos)

R*ights & Obligations *

• Review cutoff (sales, cash, receipts, sale returns)
• Inquires about factoring of receivables

C*ompleteness & Cutoff *

• Perform Analytical Procedure

V*aluation, Allocation & Accuracy *

• Foot subsidiary ledger
• Reconcile summary subsidiary ledger to general ledger
• Examine subsequent cash receipts
• Age receivable to test adequacy of allowance for doubtful accounts
• Discuss adequacy of allowance for doubtful accounts with management and compare to historical experience

Question 54

Typical Substantive audit procedures for Inventory

Answer 54

Presentation & Disclosure

• Review and disclosures for compliance with GAAP
• Inquire about pledging
• Review purchase and sale commitments

Existence/Occurrence

• Confirmation of consigned inventory and inventory in warehouses
• Observe inventory count

R*ights & Obligations *

• Inquire about inventory from vendors on consignment

C*ompleteness & Cutoff *

• Review cutoff (sales, sale returns, purchase, purchase returns)
• Perform Analytical Procedure
• Perform test counts and compare with client’s counts/summary
• Inquire about consigned inventory
• Account for all inventory tags and count sheets

V*aluation, Allocation & Accuracy *

• Foot and extended summary schedule
• Reconcile summary schedule to general ledger
• Test inventory cost method
• Determine that inventory is valued at lower of cost or market

Question 55

Confirmation of Accounts Payable

Answer 55

• Confirmation may be sent to vendors
• Confirmation are to major client did business during the year, vendors with low or zero balance
• But omitted due to the availability of externally generated evidence (e.g. purchase agreement, vendor’s invoices)
• Confirmation is used bad internal control, financial position and when vendor do not send month end statement

Question 56

The search for unrecorded liabilities

Answer 56

The search for unrecorded liabilities **is an effort to discover any liabilities that may have been omitted from recorded year end payable ** - assertion of completeness

_ Typical procedures include_

** (a)** Examination of vendors’ invoices and statements both immediately prior to and following yearend.
** (b)** Examination, after year-end, of the following to test whether proper cutoffs have occurred:
1] Cash disbursements
2] Purchases
3] Unrecorded vouchers (receiving reports, vendors’ invoices, purchase orders)
(c) Analytical procedures
(d) Internal control is analyzed to evaluate its likely effectiveness in preventing and detecting the occurrence of such misstatements.

Question 57

Management/ Client Representation Letter

Answer 57

• AU 580
• UPERCV is included in the letter
• Dated no later than audit report date
• Signed by CEO and CFO and addressed to the auditor
• obtained for all periods being reported upon, even if management was not present during all of those periods
• Mandatory audit procedure – if not received → scope limitation sufficient to preclude unqualified opinion
• should include management’s disclosure to the auditor of its knowledge of fraud or suspected fraud affecting the entity
• meant to reduce the possibility of misunderstanding concerning management’s responsibility for the financial statement
• meant to complement not replace substantive test
• Representations may be limited to matters considered either individually or collectively material to the financial statements, provided management and the auditor have an agreement on materiality
  
  • **But **no materiality limitations should exist for management’s responsibility for the financial statements, the availability of financial records, the completeness of records, or communications from regulatory agencie

Question 58

Attorney Letter / Letter of Audit inquiry

Answer 58

• AU- C 501
• Primary source of evidence about litigation, claims, and assessment is the management of the client
• The auditor will prepare and arrange for management to sign a letter of inquiry to the attorney to obtain corroborating evidence
• If Attorney letter is not received, it is considered a Scope limitation
• Management requests the inquiry, but the letter should be physically mailed by the auditor
• letter is used for both SEC and non-SEC reporting firms

Question 59

Specialist

Answer 59

• AU-C 620
• The auditor must understand the methods and assumptions underlying the specialist work and must be able to evaluate the results of that work
• The specialist must understand the manner in which the auditor will be utilizing the specialist’s work to provide corroborative evidence to support the auditor’s opinion
• The auditor should consider the specialist’s competence and objectivity
• The auditor must not refer to the specialist in the audit report unless required to do so because findings form the specialist caused the auditor to: * express a qualified or adverse opinion on the financial statement ; * *add an explanatory paragraph to the audit report to emphasize a matter such as an uncertainty over whether an amount or disclosure is correct *
• Internal Auditor is not a specialist

Question 60

Fair value

Answer 60

• AU-C 501
• Management is responsible for making the fair value measurements and disclosure
• The auditor evaluates whether the Fair Value measurement are in conformity with accounting technical literature guidance
• same 3 step approache then estimate

Question 61

Related party transaction

Answer 61

• AU-C 550
• Related party: one party that controls or can significantly influence the management or operating policies of another party – the price at which a transaction occurs – vs. arm’s length
• The auditor need to evaluate the adequacy of the disclosure about the related party transactions

Question 62

What are Subsequent Events and what do they require?

Answer 62

• AU-C 560
• Subsequent events occur after the Balance Sheet Date but before the release of audit report.
• Auditor needs to make inquiries and assess if they affect the audit report.
• Subsequent events related to condition existing at balance sheet date → required Adjustment of the financial statement Examples (1) Settlement of litigation for an amount different from the liability recorded in the accounts, assuming the event causing the litigation occurred before year-end (2) Loss on an uncollectible account receivable as a result of a customer’s deteriorating financial condition that led to bankruptcy subsequent to the balance sheet date
• Subsequent events related to condition NOT existing at balance sheet date → **Disclosed **
  Examples

​

Question 63

What should an auditor do if they discover they have forgotten to perform a substantive procedure?

Answer 63

If auditor discovers that they forgot to perform a substantive procedure auditor should

1) Assess the importance of omitted procedure
2) Anything to compensate for omitted procedure
3) Perform procedure
4) Minimize reliance on the financial statemetn - notify client, regularory agencie and anyone relying on the statement

Question 64

How is a Statement of Cash Flows audited?

Answer 64

• The statement of cash flows is prepared from the other financial statements and from analyses of increases and decreases in selected account balances.
• Since the amounts included in the statement of cash flows are audited in conjunction with the audit of balance sheet and income statement accounts, only limited substantive procedures are necessary
• Foot all balances -
• Check the Math Trace Cash Flow items to other Financial Statements
• Check classifications - Operating Activities Investing Activities Financing Activities

Question 65

What are the primary risks in an audit for a typical for-profit company?

Answer 65

Auditors are there to verify that Assets & Revenues are not overstated Expenses & Liabilities are not understated Exception

• if the CPA Exam states that it is a tax-driven company flip them around

Question 66

When performing audit procedures what should auditors focus on?

Answer 66

Auditors focus first on Balance Sheet Accounts then associated Income Statement items

Question 67

Relationships predictable

analytical procedures applied as substantive procedures

Answer 67

• Relationships in a dynamic or unstable environment are less predictable than those in a stable environment
• Relationships involving balance sheet accounts are less predictable than income statement accounts (because balance sheet accounts represent balances at one arbitrary point in time)
• Relationships involving management discretion are sometimes less predictable (e.g., decision to incur maintenance expense rather than replace plant)

Question 68

The date of the audit report

Answer 68

• The date of the report is not earlier than the date on which the auditors have obtained sufficient appropriate audit evidence to support the audit opinion, normally the last day of fieldwork.
• When a subsequent event requiring note disclosure has occurred after the date of the audit report but prior to its issuance, the auditor may either dual date the report or change its date to that of the subsequent event.
• For example, assume that March 2 was the date sufficient appropriate audit evidence had been accumulated (other than that related to the subsequent event). A dual dated report would be dated as “March 2, year 1, except for note X for which the date is March 6, year 1.” Alternatively, the auditor may change the report date to March 6. This latter option is generally less desirable since the auditor’s responsibility with respect to other possible subsequent events is extended to the date of the report—here March 6.

Question 69

Financing

Answer 69

This cycle includes issuance and repurchase of debt (bank loans, mortgages, bonds payable) and capital stock, and payment of interest and dividends. Debt and capital stock transactions should be authorized by the board of directors. Often an independent trustee issues bonds, monitors company compliance with the provisions of the debt agreement, and pays interest.

For capital stock transactions, corporations may either employ an independent stock registrar and a stock transfer agent, or handle their own transactions. Normally, internal control is stronger when a stock registrar and a stock transfer agent are utilized. A stock registrar’s primary responsibility is to verify that stock is issued in accordance with the authorization of the board of directors and the articles of incorporation; the stock transfer agent’s primary responsibility is maintaining detailed stockholder records and carrying out transfers of stock ownership.

• *Major Financing Controls Frequently Missing in CPA Exam Questions**
• • (1)** Debt and equity transactions are properly approved by the company’s board of directors.
  • *(2)** An independent trustee handles bond transactions.
  • *(3)** A stock registrar and a stock transfer agent handle capital stock transactions.
  • *(4)** Canceled stock certificates are defaced to prevent their reissuance.

Question 70

Example transactions that may be indicative of related-party transactions

Answer 70

• *a.** Borrowing or lending at interest rates above or below the market rate
• • b.** Selling real estate at a price significantly different from its appraised value
  • *c.** Exchanging property for similar property in a nonmonetary transaction
  • *d.** Making loans with no scheduled repayment terms

Question 71

Procedures to identify transactions with related parties

Answer 71

• • a.** Provide audit personnel with related-party names
• • b.** Review Board of Directors’ minutes (and other committees)
• • c.** Review SEC filings
• • d.** Review client “conflict of interest” statements obtained by company from management
• • e.** Review nature of transactions with major customers, suppliers, etc.
• • f.** Consider whether unrecorded transactions exist
• • g.** Review accounting records for large, nonrecurring transactions
• • h.** Review confirmations of compensating balances for indications that balances are maintained for or by related parties
• • i.** Review legal invoices
• • j.** Review confirmations of loans receivable and payable for guarantees

Question 72

Operational Auditing

Answer 72

Operational audits, generally performed by internal auditors, typically evaluate the effectiveness and efficiency of various operational processes. As such they are similar to “performance audits” as presented in the Government Auditing Standards. In fact, the topic “operational auditing” was dropped from the AICPA Content Specification Outline when compliance auditing was added.

frequent objective of operational audits is to develop recommendations for improving performance. Other objectives include assessing performance and identifying improvement opportunities

Question 73

Procedures Completed near the End of the Audit

Answer 73

The overall review near the end of the audit ordinarily would include considering (1) the adequacy of evidence gathered in response to unexpected balances, and (2) **unusual or unexpected balances or relationships that were not previously identified **

These procedures, completed on or near the last day of fieldwork, include
• Search for unrecorded liabilities.
• Review minutes of meetings of shareholders, board of directors, and the audit committee.
• Perform analytical procedures.
• Perform procedures, including the inquiry of client’s lawyers, to identify loss contingencies.
• Perform review for subsequent events.
• Obtain representation letter.
• Evaluate audit findings (see 2. below).
• Review adequacy of disclosures using a disclosure checklist that lists all specific disclosures required by GAAP and the SEC, if appropriate.
• Review of working papers performed by manager, partner, and possibly a second partner review performed by a partner who is not otherwise involved in the engagement but to provide an independent review of the work performed. The review process helps provide assurance that audit risk is an appropriately low level, working paper documentation is adequate, and that the evidence supports the opinion being rendered.
• Communicate with the audit committee

Question 74

Requirements for related-party disclosures

Answer 74

1. The FASB Professional Standards provide accounting requirements for related-party disclosures
   a. *Nature of relationship(s)
   * b. Description of transaction(s)
   c. Dollar amount of transactions
   d. Amounts due to/from related parties, including terms
2. Transactions should reflect their substance (rather than merely their legal form)

Question 75

Information included in the inquiry to the lawyer

Answer 75

Information included in the inquiry to the lawyer:

a. Identification of the client and the date of the audit

b. A list prepared by management (or a request by management that the lawyer prepare a list) describing pending or threatened litigation, claims, or assessments for which the lawyer has been engaged and devoted substantive attention with a request that the lawyer indicate
(1) A description of the nature of the matter, progress of the case to date, and the action the company intends to take (e.g., contest vigorously)
(2) If possible, an evaluation of the likelihood and amount of potential loss
(3) Identification of any omissions from list, or a statement that the list is complete with respect to litigation, claims, or assessments

Question 76

Management Representations letter should also include

Answer 76

Management Representations letter should include also

• *a.** Financial statements
  (1) Management acknowledges its responsibility for the financial statements being prepared in conformity with GAAP
  (2) Management believes financial statements presented in conformity with GAAP
  (3) Management believes effects of uncorrected financial statement misstatements are immaterial, both individually and in the aggregate
• *b.** Completeness of information
  (1) Availability of all financial records and related data
  (2) Completeness and availability of all minutes of meetings of stockholders, directors, and committees of directors
  (3) Communications from regulatory agencies
  (4) Absence of unrecorded transactions
• *c.** Recognition, measurement, and disclosure
  (1) Management’s acknowledgement of its responsibility to design and implement programs and controls to prevent or detect fraud
  (2) Information concerning fraud or suspected fraud affecting the company
  (3) Information concerning any allegations of fraud or suspected fraud affecting the company, for example, because of communications from employees, former employees, analysts, regulators, short sellers, or other investors
  (4) Plans or intentions that may affect carrying value or classification of assets or liabilities
  (5) Information about related-party transactions and receivable or payables
  (6) Guarantee (written or oral) under which the entity is contingently liable
  (7) All significant estimates and material concentrations known to management are disclosed as per AICPA Statement of Position 94-6, Disclosure of Certain Significant Risk and Uncertainties
  (8) Violations or possible violations of laws whose effects should be considered for disclosure or as basis for recording loss contingency
  (9) Unasserted claims or assessments that entity’s lawyer has advised are probable of assertion and must be disclosed as per SFAS 5, Accounting for Contingencies
  (10) Satisfactory title to assets, liens on assets, and assets pledged as collateral
  (11) Compliance with aspects of contractual agreements that may affect financial statements

Question 77

Relationship with repairs and maintenance.

Answer 77

A PP&E acquisition may improperly be recorded in the repair and maintenance expense account. Therefore, an analysis of repairs and maintenance may detect understatements of PP&E. Alternatively, an analysis of PP&E may disclose repairs and maintenance that have improperly been capitalized, thereby resulting in **overstatements **of PP&E.