Final Exam Flashcards
Financial Audit
Carrying out a thorough examination of an entity’s books and records, financial accounts, and policies and procedures
Who performs Audits?
External, independent auditors who are certified public accountants (CPAs)
Internal controls
Procedures or systems which are designed promote efficiency, safeguard assets, avoid fraud and errors, and keep accounting data accurate
Five Elements of Internal Controls
- Control environment - management must set an ethical tone
- Risk assessment - put policies in place to mitigate risks
- Control activities - procedures/policies to protect its assets
- Information/communication - those policies/procedures must be communicated to employees
- Monitoring - follow-up on rules
Sampling
Using a random subset of the population in order to form an opinion on the population as a whole
Audit evidence
Information gathered by the auditors for their analysis
Materiality
Refers to the size of an error in the financial statements. Big enough to affect the decision of a reasonable person looking at the mistake but not knowing its there
Public Company Accounting Oversight Board (PCAOB)
Under SEC… oversees the auditing of publicly help companies
Sarbanes-Oxley (Sarbox) implications for auditors
- Second partner review
- “Quality Review” by PCAOB every year
- Can’t provide consulting services to audit clients
- Lead auditor must rotate every five years
Sarbox implications for companies
- Audit committee: oversights of internal audit, independent & one must have financial expertise, hires and receives report from independent auditors
- Limits loans made to executives
- Section 404 internal control audit required
What do public accounting firms provide? Explain each.
Assurance services: independent, professional services that improve information quality (audits of financial statements/internal controls)
Non-assurance services: tax preparation/planning, fraud investigations, information technology consulting
Opinions on audits
Unmodified, qualified, adverse, or disclaimer opinion
Generally accepted auditing standards (GAAS)
Standards that all auditors must follow to make their job uniform for everyone
Unmodified opinion
AKA clean, which means that the auditors have found the financial statements to be in accordance with GAAP or IFRS (best opinion a company can get)
Qualified opinion
Means the auditors found something they wanted to bring to light but other than that they statements are correct
Fraud Triangle
Qualities of someone who may commit fraud: financial need, see an opportunity that is unlikely to be detected, or they have convinced themselves of entitlement (employee feels he should’ve gotten a raise)
Details of Sarbanes - Oxley Act (Know the two sections as well)
Corporate governance - Making firms improve their overall ethical operations. Requires publicly held companies to create an “audit committee” aka the “supervisory committee”. They are in charge of hiring the external auditing firm, maintaining proper statements, and can’t be employees of the company. It also requires management to sign an agreement known as Section 302 that promises they properly audited their statements.
Requirements for Auditors - Auditors can have no other job for the company but to audit. Created the Public Company Accounting Oversight Board (PCAOB). Requires auditing companies to provide opinions on financial statements, and Sec. 404 where the auditing firm gives an opinion on the company’s internal controls.
How is managerial different from financial?
Managerial is:
- Primarily internal
- Governed by management not GAAP
- Future-oriented not historical
- Quantified and non-financial info versus quantified financial statements
Formula for cost of inventory for a manufacturing firm
Direct materials + direct labor + manufacturing overhead = product costs
Manufacturing overhead costs
Indirect materials, indirect labor, and all other manufacturing costs
Two types of product costing
Job order costing: costs are accumulated by jobs. Used when the product produced is specific.
Process costing: costs are averaged over all units. Used in the manufacture of uniform or homogeneous products.
Relevant range
The range or production in which the company expects to operate.
Mixed costs
Costs that have some fixed and some variable components.
Step costs
Costs that increase in a step manner rather than gradually.
Finding the breakeven point in dollars
Total fixed costs / contribution margin ratio
Finding sales in units to achieve a certain net income.
(Total fixed costs + target income) / contribution margin per unit
Sales in dollars to achieve a target net income
(total fixed costs + target income) / contribution margin ratio
Breakeven point in units
Total fixed costs / contribution margin per unit
Proprietorship and taxes
Owned by one individual, so all net income flows through the owner to pay taxes. Pays tax on the taxable income, not amount of cash withdrawn.
Partnerships and taxes
Owned by two or more parties, not incorporated. The partnership files a tax return but does not pay tax. Income flows through the owners to pay taxes on their individual returns.
Regular corporations and taxes
A business that is incorporated and has to file a tax return and pay corporate tax. Tax is paid on taxable income at corporate level AND dividends are not deductible to the corporation but are taxable income to stockholders.
What happens if a corporation is a stockholder?
Dividends Received Deduction is:
- 70% of dividend, if own less than 20% of corporation
- 80% of dividend, if own between 20% and 80% of corporation
- 100% of dividend, if own greater than 80% of corporation
S Corporations
Business who is incorporated, but chose to be taxed as a partnership. Same exact taxing process as a partnership. Hard to meet qualifications to be “S” status
Limited-liability Companies (LLCs)
Elected to be treated as an association having some characteristics of a corporation and some of either a prop. or partnership. They have limited liability (like corps.) and flow-through taxation (like props and partners).
Taxable income equation
Gross income realized - exclusions = gross income recognized for tax purposes - deductions = taxable income (then to tax bracket) - tax credits = total tax owed
Marginal tax rate
The tax rate at which your next dollar would be taxed. Helps decide whether to invest in a project or not.
