Final

Question 1

6 Principles of Professional Ethics

Answer 1

Responsibilities
The Public Interest
Integrity
Objectivity and Independence
Due Care
Scope and Nature of Services- auditors cannot do any other type of work besides audit

Question 2

Examples of covered members

Answer 2

An individual on the attest engagement team- Can be rotated
Individual who may influence engagement (e.g., boss of engagement partner).
Other partners in engagement office- Can be rotated,
Certain partners and managers who provide nonattest services to the client

Question 3

An accounting firm should not do these inappropriate things

Answer 3

Audit its’ own work.
Function as part of management or as an employee of the audit client.
Act as an advocate for the client.- Auditor should not defend the client or promote them

Question 4

Bookkeeping services an auditor should not do

Answer 4

Prepare or originate source data underlying the financial statements.
Maintain or prepare client’s accounting records.
Prepare financial statements.

Question 5

Limited Liability Partnerships (LLP)

Answer 5

Single layer of taxation, personal assets are safe unless partner was on the engagement
Most common form of organization

Question 6

CPAs in Business- Applicable Rules

Answer 6

Integrity and Objectivity.
General Standards
Compliance with Standards
Accounting Principles
Acts Discreditable

Question 7

CPAs in Business- Non applicable rules

Answer 7

Rules ordinarily not applicable:
Independence
Contingent fees
Commissions and Referral Fees
Advertising and Solicitation
Confidential Client Information
Form of Organization and Name

Question 8

Statutory Law

Answer 8

Codified law written by a formal law making body- Congress

Question 9

Common Law

Answer 9

Law created by judges during court cases- opinions written by judges because statutory is unclear. Law they make has precedence over future cases

Question 10

Auditor legal strategies

Answer 10

Improve the quality of auditing.
Increasing insurance coverage
Reporting more conservatively-happens most often
Lobbying legislators for legal reform.
Being more selective in obtaining and retaining clients.
Get out of audit practices altogether to reduce liability exposure.
Many mid-sized firms stopped auditing publicly traded companies because they would not be able to handle a lawsuit.

Question 11

Common Law- Liability to clients

Answer 11

Most frequent lawsuits against CPA’s
Lawsuits by the legal entity, not the shareholders
$ amount is generally small
Little publicity
Burden of proof- plaintiff, above 50%, more likely than not guilty

Question 12

What does the plaintiff have to prove in a common law lawsuit? (By client or third parties)

Answer 12

.Duty—the CPA accepted a duty of care to exercise skill, prudence, and diligence. This is ordinarily easy to prove since by accepting an engagement a CPA assumes a responsibility to exercise due care.
Breach of duty—auditor violated contract
Loss—the client suffered a loss.
Proximate Cause— client must proved that they were harmed, and their loss was caused by auditors breach of duty

Question 13

Ultramares Approach

Answer 13

Auditor not liable for ordinary negligence to a third party who was not in contractual privity, unless the third party was a third party beneficiary.
Audit must have been done for the third party to be liable for ordinary negligence, ex. For a bank to get a loan, and identity of 3rd party must be known

Question 14

Restatement of Torts Approach

Answer 14

Audit must have been done for a third party, but identity of third party does not have to be known, Forseen Third Party

Question 15

Rosenblum Approach

Answer 15

Auditor has duty to anyone they would have expected to use the financial statements, Forseeable third party

Question 16

Right of Subrogation

Answer 16

This is a situation in which the third party “steps into the shoes of the client” recovery wise and can recover for ordinary negligence.

Question 17

Statutory Law (1933)- Liability to Third Parties

Answer 17

Outlined situations where auditors would have to pay damages in court. Auditors can be sued for ordinary negligence
Purchasers of new securities may sue, auditors have burden of proof

Question 18

Statutory Law (1934)- Liability to Third Parties

Answer 18

All buying and selling of securities

Third party investors may sue, plaintiff has burden of proof

Question 19

Statutory Law (1934) burden of proof

Answer 19

Plaintiff must prove they had a loss, they relied on the financial statements, and the financial statements were misstated

Question 20

Proportionate Liability versus Joint and Several Liability

Answer 20

Proportionate—20% liable, only pay 20% of damages.
Joint and several—20% liable can pay up to 100% if other defendants don’t have money. Everyone is liable for up to 100% of damages

Question 21

Management representation letter and management letter

Answer 21

Management Representation Letter- written letter of representations summarizing the most important oral representations made during the year to auditor.
Management Letter- From the auditor to the client, makes recommendations. Not required but a professional courtesy

Question 22

Engagement completion document

Answer 22

Formal document at the end of the audit, documents, disagreements with management

Question 23

Date of audit report

Answer 23

Most important milestone

Rule: Cannot date the audit report sooner than obtained sufficient evidence to justify opinion. Last day of fieldwork

Question 24

Phases of the audit

Answer 24

Interim Period
Subsequent Period- balance sheet date through date of audit report
Report Preparation Period- responsibility only covers subsequent events that come to their attention; client tells auditor or news story they see. They do not need to look for any events. Between date of the audit report and report release date
After Report-After report release date

Question 25

Audit procedures to determine subsequent events.

Answer 25

Obtain understanding of management’s procedures to ensure that subsequent events are identified.
Management inquiry.
Read minutes- Shareholder board meeting minutes
Read interim financial statements.

Question 26

Type I and Type II events

Answer 26

Type I - events that provide additional evidence as to conditions that existed at the date of the balance sheet
Type II - events that provide evidence with respect to conditions that arose subsequent to that date.

Question 27

Audit findings to report to the audit committee

Answer 27

Qualitative aspects of the entity’s significant accounting policies.
Significant difficulties encountered during the audit.
Uncorrected misstatements.
Disagreements with management (over accounting, or auditing issues)
Management’s consultation with other accountants.
Significant issues discussed, or subject to correspondence with management.

Question 28

Quantitative and Qualitative audit findings

Answer 28

Quantitative: Income, EPS, Total assets, Owners’ equity
Qualitative: Changes loss to income, Effect on compliance with loan covenants and contracts, Increases management’s compensation

Question 29

2 ways of accounting for misstatements from previous years

Answer 29

Iron Curtain Method- cumulative effect of all misstatements from this year and prior years. Only one of these methods needs to come up material. Helps to find misstatements that offset each other.
Rollover method- misstatements from current year

Question 30

3 types of misstatements

Answer 30

Factual Misstatements — Specific misstatements identified during the course of the audit for which there is no doubt.
Judgmental Misstatements — Differences arising from judgments of management that the auditor consider incorrect.
Projected Misstatements — Arise from sample results projection to population

Question 31

Types of unmodified opinions

Answer 31

Unmodified standard
Unmodified with an emphasis of matter paragraph-auditor highlights something
Unmodified with an other matter paragraph
Unmodified on group financial statements

Question 32

Reasons for an Emphasis of matter paragraph

Answer 32

Substantial Doubt about a Company’s Going-Concern Status
GAAP Not Consistently Applied
Uncertainties
Group Financial Statements

Question 33

Reasons for a Basis of Modification paragraph

Answer 33

Departures from GAAP

Scope Limitations

Question 34

Critical Audit Matter

Answer 34

Related to things in the account, geared more toward how the audit was performed and what made it difficult.
Arises from the audit and communicated or required to be communicated to the audit committee.
Relates to accounts or disclosures that are material to the financial statements.
Involved especially challenging, subjective, or complex auditor judgment.

Question 35

Emphasis of matter, group financial statements, other matter paragraphs

Answer 35

Emphasis of matter-Auditors just want to highlight something in the financial statements
Other matter- Highlights something NOT in the financial statements
Group Financial Statements- 2 or more CPA firms auditing parent/ subsidiaries
Core opinion does not change with either

Question 36

Adverse opinion vs. Disclaimer of opinion

Answer 36

Adverse opinion—An adverse opinion states that the financial statements are NOT pre¬sented fairly in conformity with GAAP
Disclaimer of opinion—Due to a significant scope limitation, or going concern issue, the auditor was unable to obtain sufficient appropriate audit evidence, expresses no opinion
Both are material and pervasive, a non pervasive would result in a qualified opinion

Question 37

Uncertainties

Answer 37

Auditor has option of adding emphasis of matter paragraph, unless it is a going concern issue or lack of consistency
Ex. Lawsuit against the company or government actions

Question 38

3 circumstances that lead to scope limitation

Answer 38

Circumstances beyond the control of the client (e.g., important accounting records were destroyed). 
Circumstances relating to the nature and timing of the auditors’ work (e.g., the auditors are hired too late to observe the client’s beginning inventory). 
The client (for example, the client refused to allow the auditors to send confirmations to customers).

Question 39

6 main parts of a company audit report

Answer 39

What the auditors did
Opinion of auditor
Mention of internal controls
Managements responsibility 
Auditors responsibility
Standards used

Question 40

Reasons shareholders value audit reports

Answer 40

To lower:
Business risk- success of business
Information risk- Risk that financial statements are not accurate
Agency costs- consequences that an agent my follow their own best interests

Question 41

Sampling risk

Answer 41

The possibility that a properly drawn sample may not be representative of the underlying population. The auditor may thus form a different conclusion

Question 42

3 criteria to use negative confirmations

Answer 42

Risk of misstatement is low
Low numbers of accounts
High response rate on last year’s confirmations

Question 43

Purpose of an audit

Answer 43

To provide reasonable assurance that the financial statements are free from material misstatements arising from noncompliance

Question 44

Bank balance 8/31- Book balance 8/31 reconciliation

Answer 44

Balance 8/31
\+ Deposits in transit 8/31
- Outstanding checks 8/31
\+ Bank service charge August
-Interest earned August
=Book balance 8/31