Final Exam (8-10, 17)

Question 1

audit report

Answer 1

Providing an independent and expert opinion on the fairness of financial statements through an audit is the most frequent attestation service

Question 2

When performing an audit under GAAS, the auditors obtain __________ that the statements are in conformity with GAAP

Answer 2

reasonable assurance

Question 3

Reports on the financial statements ordinarily include an opinion that is on both the

Answer 3

financial statements themselves (BICs) and financial statement disclosures

Question 4

what is considered an integral part of he financial statements

Answer 4

notes to the financial statements

Question 5

auditors’ standard report - public clients must

Answer 5

1) Includes the words “Registered” and “Independent” in the title “Report of….”.
2) Must be addressed to shareholders and board of directors (additional parties are allowable).
3) References auditing standards of the PCAOB.
4) Provides a discussion of auditor and management responsibilities.
5) Includes a paragraph indicating that the auditors have also issued a report on the client’s internal control over financial reporting, or is a combined report on both the financial statements and internal control
6) Includes a Critical Audit Matters Section. (NEW requirement starting in 2019)
7) Includes statement on year audit firm began serving the client.
8) Signed with name of CPA firm not individual partner (but movement to have the partner’s name on the letter)
9) Includes the City of the office with responsibility for the audit
10) Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion (typically the date used is the filing date of the 10K with the SEC)

Question 6

auditors’ standard report - nonpublic clients

Answer 6

1) Title that includes the word independent
2) Ordinarily addressed to the company itself, the shareholders, the audit committee, and/or the board of directors
3) Signed with name of CPA firm not individual partner unless the firm is a sole practitioner
4) Dated no earlier than the date on which the auditors obtained sufficient appropriate audit evidence to support their opinion

Question 7

PCAOB Critical Audit Matter includes

Answer 7

1) Identification of the CAM
2) Description of the principal considerations that led the auditor to determine that the matter was a CAM
3) Description of how the CAM was addressed in the audit
4) Reference to the relevant financial statement accounts or disclosures

Question 8

condition required for issuance of unmodified opinion

Answer 8

The auditors are able to obtain sufficient appropriate audit evidence to obtain reasonable assurance so as to be able to conclude that the financial statements as a whole are free from material misstatements

Question 9

Unmodified opinion - standard report

Answer 9

This report may be issued only when the auditors have obtained sufficient appropriate audit evidence to conclude the financial statements are not misstated and there is no need to alter the report for other situations

Question 10

Unmodified opinion - with an emphasis of matter paragraph

Answer 10

To emphasize a matter appropriately presented in the financial statements (e.g., a change in accounting principle)

Question 11

Unmodified opinion - with an other matter paragraph

Answer 11

To emphasize a matter other than those presented or disclosed in the financial statements (e.g., other information in documents containing audited financial statements) – special purpose example

Question 12

Unmodified opinion on group financial statements

Answer 12

When two or more CPA firms are involved in an audit and the group auditor (firm that does most of the work) does not wish to take responsibility for the work of the component auditors

Question 13

Qualified opinion

Answer 13

states that the financial statements are presented fairly in conformity with generally accepted accounting principles “except for” the effects of some matter

Question 14

Adverse opinion

Answer 14

states that the financial statements are not presented fairly in conformity with generally accepted accounting principles

Question 15

Disclaimer of opinion

Answer 15

means that due to a significant scope limitation, the auditors were unable to form an opinion or did not form an opinion on the financial statements

Question 16

Going concern effect on audit report if the matter is properly presented

Answer 16

unmodified opinion with an emphasis of matter paragraph added after the opinion paragraph (may also lead to disclaimer of opinion)

Question 17

Consistency effect on audit report if the matter is properly presented

Answer 17

unmodified opinion with an emphasis of matter paragraph added after the opinion paragraph

Question 18

Auditor discretionary effect on audit report if the matter is properly presented

Answer 18

unmodified opinion with an emphasis of matter paragraph added after the opinion paragraph

Question 19

Going concern effect on audit report if the matter is improperly presented in financial statements

Answer 19

a departure from GAAP is involved and the auditors modify the opinion paragraph to either a qualified or adverse opinion and add a basis for modification paragraph preceding the opinion paragraph

Question 20

Group audits effect on audit report if the matter is properly presented

Answer 20

Unmodified opinion. The component auditors are referred to when they do not take the responsibility for the component auditors’ work. If they take responsibility, no modification of the audit report is necessary

Question 21

Group audits effect on audit report if the matter is improperly presented in financial statements

Answer 21

Not applicable because it is an auditor reporting concern

Question 22

Before opinion paragraph

Answer 22

basis for modification (qualified, adverse, disclaimer) paragraphs, for a modified opinion, such as a qualified or disclaimer, we want to prepare the reader for what is coming and provide context for our opinion, the emphasis of matter is BEFORE the opinion paragraph

Question 23

After opinion paragraph - unqualified / unmodified

Answer 23

emphasis of matter and other matter paragraphs, for unmodified, the emphasis of matter is typically AFTER the opinion paragraph, in the case of an unmodified or unqualified opinion, as auditors we want to FIRST tell the reader what our conclusion is and THEN tell them so extra information that entered into our decision-making process

Question 24

Disclaimer of opinion

Answer 24

1) Auditor has no opinion
2) Issued whenever unable to form an opinion as to fairness of financial statements
3) Circumstances resulting in a disclaimer are those in which the possible misstatements are material and pervasive
4) Multiple uncertainties may also lead to a disclaimer
5) Not an alternative to adverse opinion

Question 25

Requirement for going concern

Answer 25

must evaluate

Question 26

5 conditions indicating a going concern

Answer 26

1) Negative cash flows from operations
2) Defaults on loan agreements
3) Adverse financial ratios
4) Work stoppages
5) Legal proceedings

Question 27

substantial doubt as to going concern status

Answer 27

Ordinarily an unmodified opinion with an emphasis of matter paragraph issued. Alternatively, a disclaimer of opinion may be issued

Question 28

pervasive misstatements

Answer 28

1) Not confined to specific accounts
2) If confined, they represent a substantial proportion of the financial statements
3) In relation to disclosures, they are fundamental to users’ understanding of the financial statements

Question 29

adverse opinion

Answer 29

1) Financial statements do not present fairly the financial position, results of operations, and cash flows of client in conformity with GAAP
2) Material and pervasive departures from GAAP
3) Auditor believes departure causes financial statements taken as a whole to be misleading

Question 30

reporting on comparative financial statements

Answer 30

1) Report should cover current year as well as prior period audited by their firm
2) Can express different opinions on different years

Question 31

different opinions on different statements

Answer 31

It is acceptable to express an unqualified opinion on one statement while expressing a qualified or adverse on the others

Question 32

8-K report

Answer 32

major developments that investors should know about are described in the 10-K or 10-Q, but if those developments don’t make the two filings in time, they are presented here. Addresses specific events and provides further detail and exhibits

Question 33

events that lead to the filing of the 8-K

Answer 33

bankruptcy or receivership, material impairments, completion of acquisition or disposition of assets, departures or appointments of executives

Question 34

10-Q report

Answer 34

a truncated version of the 10-K, provided within 45 days of the end of the first three quarters of the company’s fiscal year, details company’s latest developments and provides a preview of the direction it plans to take

Question 35

major differences between 10-K and 10-Q

Answer 35

10-Q has unaudited financial statements and less detailed reports

Question 36

10-K

Answer 36

provides investors with a comprehensive analysis of the company, contains more information than an annual report, more detailed financial statements, submit within 90 days of the end of the fiscal year,

Question 37

Sections of the 10-K

Answer 37

1) Business summary that describes the company’s operations, business segments, history, real estate, marketing, research and development, competition and employees
2) The management discussion and analysis that provides a good explanation of the company’s operations and financial outlook
3) Financial statements
4) Management team and legal proceedings

Question 38

What does the filing time of the 10-Q and 10-K depend on?

Answer 38

market cap

Question 39

What is the the primary resource for investors to determine if they want to invest in that business?

Answer 39

reports to the SEC

Question 40

less expensive software

Answer 40

Electronic checkbooks (e.g., Quicken: checkbook only)

Question 41

moderate system

Answer 41

Basic general ledger system (e.g., QuickBooks or Peachtree)

Question 42

large and expensive

Answer 42

ERP systems (e.g., SAP, Oracle, JD Edwards)

Question 43

National Institute of Standards and Technology (NIST)

Answer 43

1) Federal agency within the US Department of Commerce

2)Published a comprehensive cybersecurity framework (CSF) in response to President Obama’s executive order

3) Adoption is voluntary

4) HOWEVER, many companies have adopted this standard to govern their IT security AND most audit firms have adopted this as the standard by which they will measure their clients IT security efforts

5) Designed to not only to keep the cyber criminals out of your data, but to assure nothing happens internally to make your computing environment unavailable or subject to processing errors

Question 44

What are the 5 governing controls of the NIST Cyber Security Framework?

Answer 44

Identify
Protect
Detect
Respond
Recover

Question 45

Identify

Answer 45

Understanding by management on how to manage cybersecurity risk to systems, assets, data, and capabilities

1) Asset Management
2) Business Environment
3) Governance
4) Risk Assessment
5) Risk Management Strategy

Question 46

Protect

Answer 46

Standards to ensure delivery of critical infrastructure services

1) Access Control
2) Awareness and Training
3) Data Security
4) Info Protection Processes and Procedures
5) Maintenance
6) Protective Technology

Question 47

Detect

Answer 47

Identify the occurrence of a cybersecurity event

1) Anomalies and Events
2) Security Continuous Monitoring
3) Detection Processes

Question 48

Respond

Answer 48

Action regarding a detected cybersecurity event

1) Response Planning
2) Communications
3) Analysis
4) Mitigation
5) Improvements

Question 49

Recover

Answer 49

Maintain plans for resilience and restore any capabilities or services

1) Recovery Planning
2) Improvements
3) Communications

Question 50

Top 20 IT Security Controls

Answer 50

1) Inventory of Authorized Devices

2) Inventory of Authorized Software

3) Secure Configurations for mobile devices, servers, laptops, etc

4) Continuous Vulnerability Assessments

5) Controlled Use of Administrator Privileges

6) Monitoring of Server Audit Logs

7) Email Protection (Phishing) and web site restrictions

8) Control the Spread of Malware

9) Management of Network Ports

10) Effective Backup and Recovery Processes

11) Configure Routers and Firewalls

12) Keep Bad Guys Out of your Network and Alert for Intrusions (IDS, SIEM)

13) Use Data Loss Prevention Tools

14) “Need-to-Know” Only Access

15) Secure Wireless Access Points

16) Actively Manage User Accounts

17) Develop Plan to Assess/Remediate Gaps in IT Security

18) Application Software Security

19) Cyber Incident Response & Management

20) Penetration Tests & Simulations

Question 51

IT systems usually consist of (2)

Answer 51

hardware and software

Question 52

hardware

Answer 52

Digital computer and peripheral equipment

Question 53

software

Answer 53

Various programs and routines for operating the system

Question 54

two types of software

Answer 54

systems and application

Question 55

systems software

Answer 55

Programs that control and coordinate hardware components and provide support to application software
Operating system (Examples: Unix, Windows)

Question 56

application software

Answer 56

Programs designed to perform a specific data processing task
Written in programming language (Example: Java)

Question 57

input/output devices

Answer 57

1) card readers
2) terminals
3) electronic cash registers
4) optical scanners
5) magnetic tape drives
6) magnetic disk drives
7) optical compact disks

Question 58

central processing unit (CPU)

Answer 58

1) Arithmetic unit
2) Control unit
3) Primary storage

Question 59

auxiliary storage

Answer 59

1) magnetic disks
2) magnetic drums
3) magnetic tapes
4) optical compact disks
5) flashdrives
6) cloud storage

Question 60

system characteristics

Answer 60

Batch processing
Online capabilities
Database storage
IT networks
End user computing

Question 61

batch processing

Answer 61

Input data gathered and processed periodically in groups

Often more efficient than other types of systems but does not provide up-to-minute information

Question 62

example of batch processing

Answer 62

Accumulate all of a day’s sales transactions and process them as a batch at end of day

Weekly moving students in or out of canvas sections

Question 63

two types of online capabilities

Answer 63

online transaction processing (OLTP) and online analytical processing (OLAP)

Question 64

online transaction processing (OLTP)

Answer 64

Individual transactions entered from remote locations
Online real time (Example: Bank balance at ATM)

Question 65

online analytical processing (OLAP)

Answer 65

Enables user to query a system for analysis
Example: Data warehouse, decision support systems, expert systems (SW: Expert Choice)

Question 66

database system

Answer 66

allows users to access same integrated database file
Eliminates data redundancy
Creates need for data administrator for security against improper access
Commonly used term “Data Warehouse”

Question 67

networks

Answer 67

Computers linked together through telecommunication links that enable computers to communicate information back and forth
WAN, LAN
Internet, intranet, extranet, VPN, Cloud computing, …

Question 68

electronic commerce

Answer 68

Involves electronic processing and transmission of data between customer and client
Electronic Data Interchange (EDI)
Soon arriving on the scene – Block Chain Technology

Question 69

end user computing

Answer 69

1) User departments (such as the Accounting Department) are responsible for the development and execution of certain IT applications (mostly on PCs)
Involves a decentralized processing system

2) IT department generally not involved

3) Controls needed to prevent unauthorized access and unauthorized modifications

4) Examples: Excel – the “IT solution” of choice for many businesses (large and small). Cloud-based solutions that allow company data to be easily processed with just the use of a provided credit card. Various “off-the-shelf” systems such as Access, Tableau, and UiPath (Robotic Process Automation) that allow the user to create their own “system” for analyzing data and potentially using that data to book accounting entries. HIGH FOCUS AREA for auditors due to risk

Question 70

internal control in IT

Answer 70

Separation of duties
Clearly defined responsibilities
Augmented by controls written into computer programs

*** Key is preserving data integrity

Question 71

audit trail impact

Answer 71

Can affect audit procedures
Consulting auditors during design stage of IT-based system helps ultimate auditability

Question 72

computer-based fraud

Answer 72

History shows the person responsible for frauds in many situations set up the system and controlled its modifications
Segregation of duties – KEY!
Programming separate from controlling data entry
Programming separate from the “move to production” of software changes
Business unit sign-off/approval of all changes/updates
Computer operator from custody or detailed knowledge of programs
If segregation not possible need:
Compensating controls like batch totals
Organizational controls not effective in mitigating collusion

Question 73

if segregation is not possible what is needed

Answer 73

Compensating controls like batch totals

Question 74

general control activities

Answer 74

Access to programs and data

Developing new programs and systems

Changing existing programs and systems

IT operations controls

Question 75

application control activities

Answer 75

programmed (automated) control activities, manual follow-up activities

Question 76

programmed (automated) control activities

Answer 76

input validation checks, batch controls, processing controls

Question 77

input validation checks

Answer 77

Limit test (predefined upper and lower limit)
Validity test (data entered compared to master data)
Allowed character test (numeric or alpha or combo)
Missing data test (are all required fields entered)
Self-checking number (last digit in account # is mathematical calc of preceding numbers)

Question 78

batch controls

Answer 78

Item count (record count)
Control total (total sales processed)
Hash total (similar to control total, but has no intrinsic meaning – ex: sum of social security numbers)

Question 79

processing controls

Answer 79

Input controls noted above to assure data is processed accurately by the IT application

Question 80

manual follow-up activities

Answer 80

Exception reports follow-up

Question 81

user control activities

Answer 81

Designed to test the completeness and accuracy of IT-processed transactions
Designed to ensure reliability
Reconciliation of control totals generated by system to totals developed at input phase
Example: Sales invoices generated by IT-based system tested for clerical accuracy and pricing by the accounting clerk
Important for auditors to determine how does the user gain comfort that key reports that are computer generated contain accurate data

Question 82

example of Reconciliation of control totals generated by system to totals developed at input phase

Answer 82

Sales invoices generated by IT-based system tested for clerical accuracy and pricing by the accounting clerk

Question 83

control in decentralized and single workstation systems

Answer 83

Involves use of one or more user operated workstations to process data

Question 84

needed controls for decentralized and single workstation systems

Answer 84

Train users
Document computer processing procedures
Backup files stored away from originals
Authorization controls (i.e. passwords)
Prohibit use of unauthorized programs
Use antivirus software
Lockdown workstations from installation of unauthorized software or for the user’s ability to turn off anti-virus programs

Question 85

techniques for testing application controls

Answer 85

Auditing Around the Computer–Manually processing selected transactions and comparing results to computer output

Manual Tests of Computer Controls–Inspection of computer control reports and evidence of manual follow-up on exceptions

Auditing Through the Computer–Computer assisted techniques

Question 86

auditing through the computer - computer assisted techniques

Answer 86

Test Data
Integrated Test Facility
Controlled Programs (or testing controls w/in program)
Program Analysis Techniques
Tagging and Tracing Transactions
Generalized audit software – parallel simulation

Question 87

using generalized audit software to perform substantive procedures

Answer 87

Examine client’s records for overall quality, completeness and valid conditions
Rearrange data and perform analyses
Select audit samples
Compare data on separate files
Compare results of audit procedures with client’s records

Question 88

typical inventory audit procedures using generalized audit software

Answer 88

1) observe the physical count, making appropriate test counts

2) test the mathematical accuracy of the inventory extensions and footings

3) compare the auditors’ test counts to the inventory records, book to floor

4) compare the client’s physical count data to the inventory records, floor to book

5) perform a lower of cost or market test by obtaining a list of current costs from per item from vendors

6) test purchase and sales cutoff

7) confirm the existence of items located in public warehouses

8) analyze inventory for evidence of obsolescence or slow moving items. Companies are generally reluctant to write off such items due to income statement impact

Question 89

observe the physical count, making appropriate test counts

Answer 89

determine which items are to be test counted by selecting from the inventory file a sample of items that provides the desired dollar coverage

Question 90

test the mathematical accuracy of the inventory extensions and footings

Answer 90

for each item in the inventory file, multiply the quantity on hand by the cost per unit and add the extended amounts

Question 91

compare the auditors’ test counts to the inventory records, book to floor

Answer 91

organize the auditors’ test counts and compare them to inventory records

Question 92

compare the client’s physical count data to the inventory records, floor to book

Answer 92

compare the quantity of each item counted to the quantity on hand in the inventory file

Question 93

perform a lower of cost or market test by obtaining a list of current costs from per item from vendors

Answer 93

compare the current costs per unit to the cost per unit in the inventory file; print out the extended value for each item, using the lower of the two unit costs, and add extended amounts

Question 94

test purchase and sales cutoff

Answer 94

list a sample of items on the inventory file for which the date of last purchase or last sale is on, or immediately before, the date of the physical count

Question 95

confirm the existence of items located in public warehouses

Answer 95

list items located in local warehouses and print confirmations

Question 96

analyze inventory for evidence of obsolescence or slow moving items. Companies are generally reluctant to write off such items due to income statement impact

Answer 96

list items from the inventory file for which the turnover ratio (quantity sold divided by quantity on hand) is low for which the date of last sale indicates a lack of recent transactions

Question 97

controls when using cloud computing

Answer 97

management must take responsibility for controls

must be coordinated and integrated with provider

Question 98

computer service centers

Answer 98

provide outsourced processing/computer infrastructure services to customers who decide not to invest in their own processing of particular data. Such providers are referred to as Infrastructure as a Service

Question 99

examples of computer service centers

Answer 99

Microsoft Azure; Amazon Web Services; Google

Question 100

outsourced service provider

Answer 100

also offer a Software as a Service (SaaS) solution. Rather than having the software installed locally, the software is owned and housed by the 3rd party in their own IT environment

Question 101

outsourced service provider examples

Answer 101

QuickBooks on-line; Microsoft 360; Drips

Question 102

what are computer service centers and outsourced service providers?

Answer 102

cloud service providers which opens up significant risk for the auditor to evaluate

Question 103

cloud computing key concerns

Answer 103

How does the cloud provider and the client assure the completeness, accuracy and validity of the processed data.

What controls are in place on the client’s side concerning the above (Some cloud providers actually specify these in their contracts)

How is data returned back to the client for inclusion in their financial system

What ITGC’s are in place to protect data while in transit and at rest from unauthorized viewing or manipulation while in the possession of the cloud provider

Question 104

what reports are the auditor’s best friend

Answer 104

SOC 1 and/or SOC 2

Question 105

what makes the cloud a very attractive option

Answer 105

its ease of setup for new applications and cost effectiveness

Question 106

SSAE #18 report

Answer 106

For Service Providers that impact a company’s internal control environment

Question 107

examples of service providers

Answer 107

Payroll Service
Bank Trust Departments
Claims Processing Centers
Data Centers
Third Party Administrators, etc.
In general, any provider that’s in the cloud

Question 108

SOC 1 Report

Answer 108

For providers that “crunch the numbers” and provide the results back to the company for inclusion in their financials

Question 109

SOC 2 Report

Answer 109

Mainly for companies that provide server hosting, such as Amazon Web Services, Microsoft Azure, & Google where you are mainly concerned with availability and security of your data

Question 110

Type 1 and Type 2 Reports

Answer 110

Type 1’s are basically worthless in that it only covers a point in time and only looks at control design; Type 2 looks at the functioning of controls over a period of time, much like a traditional audit, AND offers an opinion by the auditor on the effectiveness of those controls

Question 111

IT Auditor certification

Answer 111

110 Question Exam – Not just for folks with IT background
Distinguish yourself from your colleagues with specific knowledge in applying a risk based approach to plan, execute, and report on engagements involving IT technology

Question 112

sources of cash

Answer 112

General checking account
Payroll checking accounts
Petty cash
Savings accounts

Question 113

cash equivalents

Answer 113

Money market funds
Certificates of deposit
Savings certificates

Question 114

objectives for the audit of cash

Answer 114

Consider inherent risk, including fraud risks, related to cash
Obtain understanding of internal control over cash
Assess the risks of material misstatement of cash and design compliance & substantive procedures that*:
Substantiate the existence of recorded cash and occurrence of the related transactions
Establish the completeness of recorded cash
Verify the cutoff and accuracy of cash transactions
Determine that the client has rights to recorded cash
Determine that the presentation and disclosure of cash, including restricted funds, are appropriate

Question 115

why do we devote a large number of audit hours to cash

Answer 115

It is often the “heart of the organization”: liabilities, revenues, expenses and most other assets flow through cash
Our client’s most liquid asset so greater temptation for misappropriation
High risk account – cash gets “legs”

Question 116

finance and accounting departments work together to provide assurance that

Answer 116

All cash that should have been received was in fact received, recorded accurately and deposited promptly
Cash disbursements have been made for authorized purposes only and have been properly recorded
Cash balances are maintained at adequate, but not excessive, levels by forecasting

Question 117

9 guidelines for internal control over cash

Answer 117

Do not permit any one employee to handle a transaction from beginning to end.

Separate cash handling from recordkeeping.

Centralize receiving of cash to the extent practical.

Record cash receipts on a timely basis.

Encourage customers to obtain receipts and observe cash register totals.

Deposit cash receipts daily

Make all disbursements by check or electronic funds transfer, with the exception of small expenditures from petty cash.

Have monthly bank reconciliations prepared by employees not responsible for the issuance of checks or custody of cash. The completed reconciliation should be reviewed promptly by an appropriate official.

Monitor cash receipts and disbursements by comparing recorded amounts to forecasted amounts

Question 118

Bank rec add what to per bank statement

Answer 118

deposit in transit, bank errors

Question 119

Bank rec subtract what to per bank statement

Answer 119

outstanding checks, bank errors

Question 120

bank rec add what to per books

Answer 120

notes collected by bank, book errors

Question 121

bank rec subtract what to per books

Answer 121

NSF (bounced) checks, check printing or other service charges, book errors

Question 122

bank account reconciliation procedures

Answer 122

Is it being done timely and consistently (for a monthly control, pull a random sample of 3 months – may want to stratify the sample for entities with large number of bank accounts – not all bank accounts carry the same value)

Typically, you would like to see it being done prior to the final closing of the books
This will allow for major issues to be reached prior to issuing the 10K/10Q

Is it being done for ALL bank accounts

Is there a “preparer” and a “reviewer” for it, in other words, is there another set of eyes on it

SOD issue: it must be performed by someone who has no responsibility or authority over the cash collection and disbursement process? This is KEY to assure validity of the recon

Is supporting documentation attached to it?
Copy of Bank Statement (Auditor should ask employee to log into bank’s web site and observe the on-line version of the bank statement to assure it matches what’s attached to it

Copy of G/L showing cash per books

What follow-up action is taken for outstanding checks or for NSF checks?

Developing technology – Robotic Process Automation (RPA) – can automate this relatively mundane but very important task

If your client is using RPA, also make contact with your IT audit group to review the integrity of the automated process

The same processes as noted above should still be observe

Question 123

examples of cash audit procedures

Answer 123

Audit of Bank Reconciliation

Audit of Check Disbursements: 3-way match
Purchase Order
Receiving Report
Invoice

Question 124

cash disbursement process

Answer 124

purchase requisition

purchase order

notify vendor

vendor shipment

goods receipt (no access to other role)

invoice receipt

payment to vendor

Question 125

receiving document

Answer 125

The item quantity is confirmed by the company’s Receiving Department and manually entered line-by-line into the company’s ERP system under that PO number. In addition, once all items are received, the PO is closed in the system to prevent incidents of fraud such as re-ordering of the same materials without going through the proper approval process

Question 126

invoice

Answer 126

3 Way Match Documents
PO
Receiving Report
Invoice

Question 127

2 way match process

Answer 127

Similar in concept to a 3-way match process in that there needs to be a valid PO for the purchase. However, two major differences:
Used for SERVICES vs materials
NO receiving report

invoices are usually automatically routed to a designated individual to confirm the services were rendered. Once confirmation is received, and the PO is not over-spent, the invoice is paid.

Question 128

cash disbursement

Answer 128

is only initiated via ACH, wire transfer or paper check after the 3-way match has been successfully completed and the invoice presented for payment. This is typically an automated process in an ERP system (SAP, Oracle, etc)

Question 129

canceling a document

Answer 129

Once paid, the invoice is this. In addition, once the check is processed, it also is this (by the bank). Most companies use Positive Pay (verification of $ amount) and Positive Payee (verification of payee’s name)to prevent fraudulent cashing of the check

Question 130

proof of cash

Answer 130

sometimes referred to as a 4 Column Reconciliation is essentially a roll forward of each line item in a bank reconciliation from one accounting period to the next, incorporating separate columns for cash receipts and cash disbursements

Highly recommended where volume of transactions and amount of cash is very large or where fraud is suspected

Question 131

proof of cash equation

Answer 131

Beginning balance + Cash receipts in the period - Cash disbursements in the period = Ending balance

Question 132

what is proof of cash used to identify

Answer 132

Cash receipts and disbursements recorded in the accounting records, but not on the bank statement.
Cash deposits and disbursements recorded on the bank statement, but not on the accounting records.
Cash receipts and disbursements recorded at different amounts by the bank than in the accounting records

Question 133

internal controls over cash receipts

Answer 133

cash sales, collections of receivables

Question 134

internal controls over cash sales

Answer 134

Involvement of two or more employees
Cash Registers
Electronic point of sale systems

Question 135

internal controls over collection of receivables

Answer 135

Initial listing of cash receipts
Custody and depositing of cash receipts
Maintenance of customer account records
Reconciliation of customers’ ledgers with control accounts
Mailing monthly statements to customers
Collection activity and past-due accounts
Direct receipt of funds by financial institution

Question 136

internal control over cash disbursements

Answer 136

Segregation of duties most critical
Payment of obligations by check, credit card, or electronic funds transfer vs paper cash
Use of pre-numbered checks
Match of purchase order and receiving document with vendor’s invoice (3 way match – automated process)
Review of supporting documents by authorized check signer or other designated invoice approver (for non-3 way match invoices)
Cancel of supporting documents (PO and Invoice)
Authorized check signer should mail checks
Not always feasible in large corporations where checks are printed off-site using an “electronic signature”
Monthly bank reconciliation

Question 137

tests of controls over cash

Answer 137

Test the accounting records and reconciliations by reperformance.
Compare the details of a sample of cash receipts listings to the cash receipts journal, accounts receivable postings, and authenticated deposit slips.
Compare the details of a sample of recorded cash disbursements in the cash payments journal to account payable postings, purchase orders, receiving reports, invoices, and paid checks.

Question 138

tests of balances

Answer 138

Reconcile cash balances to the general ledger.
2. Confirm cash balances with financial institutions.
3. Obtain or prepare bank reconciliations as of the balance sheet date and consider the need to reconcile for additional months.
4. Obtain a cutoff bank statement containing transactions of at least seven business days subsequent to balance sheet date.
5. Count and list cash on hand.
6. Verify the client’s cutoff of cash receipts and cash disbursements.
7. Analyze bank transfers for the weeks around year end.
8. Investigate any checks to/from related parties.
9. Evaluate proper financial statement presentation and disclosure of cash.

Question 139

obtain analyses of cash balances and reconcile them to general ledger

Answer 139

existence and accuracy

Question 140

send standard confirmation forms to financial institutions. obtain reconciliations of bank balances and consider reconciling bank activity. obtain bank cutoff statement. count cash on hand

Answer 140

existence, occurrence, accuracy, cutoff, and rights

Question 141

verify the client’s cutoff of cash transactions. analyze bank transfers occurring year end

Answer 141

cutoff, existence, occurrence, rights and completeness

Question 142

investigate payments to related parties. evaluate financial statement presentation and disclosure

Answer 142

presentation and disclosure

Question 143

bank cutoff statement

Answer 143

a bank statement subsequent to the date of the balance sheet

Question 144

Check 21 Act

Answer 144

Checks may be processed electronically vs physically moving a paper check from bank to bank which is costly and time consuming
Electronic processing creates a substitute check which is an electronic image of the original check
You no longer receive your original cancelled check from the bank
Legal equivalent of original check for all purposes
Audit implications
Need to rely on substitute check for evidence of check
Almost impossible for clients to kite checks (manipulate bank balances to conceal cash shortage) due to enhanced speed for which checks are now cleared

Question 145

Kiting

Answer 145

Manipulations that utilize temporarily overstated bank balances to conceal cash shortage or meet short-term cash needs

these schemes rely upon the existence of a “float period” in which transactions are not processed in real time

Increased electronic processing has made this more difficult through reducing (or eliminating) the float period

Auditors can detect this by preparing a schedule of bank transfers for a few days before and after balance sheet date

Question 146

what is the first indication that fraud is being committed

Answer 146

the observation that someone is living beyond their means

Question 147

one standard deviation from the mean

Answer 147

accounts for 68% of the set

Question 148

two standard deviations from the mean

Answer 148

accounts for 95% of the set

Question 149

three deviations from the mean

Answer 149

accounts for 99.7% of the set

Question 150

audit sampling

Answer 150

Applying a procedure to less than 100% of a population for the purpose of drawing a general conclusion about the account balance, or the entire group of transactions, based on the characteristics detected in this

allows an auditor to draw conclusions about transactions or balances without incurring the time and cost of examining every transaction

Question 151

when is sampling used in field audits

Answer 151

when it is not efficient to review 100% of the record

Question 152

audit sampling

Answer 152

Used to estimate some characteristic of the population, either:
Qualitative: attribute sampling
Compliance Test: Tests of Controls
Quantitative: variables sampling
Substantive Test: Tests of Account Balances

Question 153

representative sample

Answer 153

one in which the characteristics in the sample of audit interest are approximately the same as those of the entire population

Question 154

what is the auditor’s primary objective when selecting a sample to review

Answer 154

making sure it is representative of the entire population

Question 155

two risks cause a sample to be non-representative

Answer 155

Sampling risk
Non-sampling risk

Question 156

sampling risk

Answer 156

Risk that an auditor reaches an incorrect conclusion because the sample is not representative of the population
Risk that the auditors’ conclusions based on a sample may be different from the conclusion they would reach IF they examined every item in the population

Question 157

two types of sampling risk

Answer 157

assessing risk too high and assessing risk too low

Question 158

assessing risk too high

Answer 158

Relates to the efficiency of the audit. Results in the auditors performing more substantive testing than necessary. Does not impact audit effectiveness

Question 159

assessing risk too low

Answer 159

Relates to the auditors assessing the control risk lower than it actually is which lessens the probability of detecting material financial misstatements. Has huge implications for the effectiveness of audit

Question 160

non-sampling risk

Answer 160

Risk that the audit tests do not uncover existing exceptions in the sample, caused by:
Auditor failure to recognize errors or exceptions
Inappropriate or ineffective audit procedures
Basically, the auditor messed up the testing

Question 161

statistical sampling

Answer 161

Applies the laws of probability theory to assist the auditor in designing a sampling plan and subsequently evaluating the results of the sample

Question 162

non-statistical sampling

Answer 162

Solely based on the auditor’s judgment

Question 163

judgmental sampling

Answer 163

The auditor estimates sampling risk by using professional judgment rather than statistical techniques

Provides no means of quantifying sampling risk

Best practice: After you select the statistical sample, review all data from the entire population and find the “outliers”

Example: Look for data points that are in the far right side of the bell curve (3 standard deviations off the mean)

Question 164

advantages of statistical sampling

Answer 164

Allows auditors to measure and control sampling risk which helps:
Design efficient samples (IE: You don’t have an unlimited amount of time to do your work)
Measure sufficient amount of evidence
Objectively evaluate sample results

Question 165

selection of random sample

Answer 165

results in a statistically unbiased sample that may or may not be a representative sample

KEY: You have to make sure you have the entire population of the data your are trying to audit prior to using any methodology to select your sample. In other words “garbage-in; garbage-out”
Not always as easy at it looks

Data in ERP system may be segregated by cost center, geographic area, company code, business segment, etc.

Random sample techniques
Random number tables – IE: “stone tablet” approach.

Although in your book, we will not cover since there are much better tools readily available
Random number generators – See Excel illustration
Systematic selection

Question 166

two types of statistical sampling plans

Answer 166

attributes sampling and discovery sampling

Question 167

attributes sampling (control testing)

Answer 167

“On” or “Off” – Look for the presence or the absence of some attribute (EX: Signature, Bill of Lading, etc)

Question 168

discovery sampling (special purpose testing)

Answer 168

Designed to detect at least one error in population or for critical deviations that are not expected to be frequent in number
Mainly used for fraud/forensics testing

Question 169

classical variables testing (substantive testing) mean per unit estimation

Answer 169

Helpful to estimate the appropriate account balance when the underlying documentation is not available.
Total population of 3,000 items in accounts receivable
Sample size is 50.
Adding up the individual values of the 50 items, you get a total of $2,000; therefore, your mean is $40 ($2,000/50). Your mean estimate of the true value of accounts receivable is $120,000 ($40 x 3,000)

Question 170

application of classical variables testing mean per unit estimation

Answer 170

Confidence level is 95 percent
Error rate is 10 percent
Conclusion: you can say that you’re 95 percent confident that the total value of accounts receivable is $120,000, plus or minus $12,000 ($120,000 times your error rate of 10 percent)

Question 171

classical variables testing ratio estimation (extrapolation)

Answer 171

Applies the sample ratio to an entire population
Sample for any of your client’s accounts shows errors of $1,000 in a total sample of $10,000, your misstatement ratio is 10 percent ($1,000/$10,000)

Question 172

classical variables testing ratio estimation (extrapolation) application

Answer 172

The above ratio is applied to the entire population.
If the entire population totals $50,000, your projected misstatement of the entire population, is $5,000 ($50,000 x 10 percent)
If this is lower than your tolerable error rate, you are good to go

Question 173

classical variables testing difference estimation

Answer 173

Similar to ratio estimation
However, it incorporates the items in the population.

Question 174

classical variables testing difference estimation

Answer 174

Total population consists of 5,000 items and your sample consists of 1,000 items. Your audit procedures find errors totaling $500. The projected misstatement is $2,500 [($500/1000 items) = $.50/item x 5,000 items].
If this is less than your tolerable error rate, you are good to go

Question 175

classical variables testing Probability-proportional-to-size (PPS) sampling (Substantiate Testing – sometimes called “monetary unit sampling”)

Answer 175

defines the sampling unit as each individual dollar making up the book value of the population
With this method, the bigger the size of the unit, the higher the chance it has of being included in the sample. For this method to bring increased efficiency, the measure of size needs to be accurate.
Contrast to random sampling where each object (invoice, inventory item, etc) has an equal probability of being selected

Question 176

allowance for sampling risk employed

Answer 176

Amount used to create a range, set by “+ or –” limits from the sample results, within which the true value of the population characteristic being measured is likely to lie (for example, plus or minus 2% error)
The wider the interval, the more confident that the true population falls within that interval; however, the increased interval size also leads to a less precise conclusion:
Sample deviation = 2%
If Allowance for Sampling Risk = +/- 1%; Actual deviation range = 1% to 3%
If Allowance for Sampling Risk = +/- 2%; Actual deviation range = 0% to 4%

Can be used to construct a dollar interval

Question 177

sample size

Answer 177

Significant effect on Allowance for Sampling Risk and Sampling Risk

As it increases, Sampling Risk and Allowance for Sampling Risk decreases

affected by characteristics of population
General rule: as population increases, it increases

Question 178

when planning the sample consider

Answer 178

The relationship of the sample to the relevant audit objective
Materiality or the maximum tolerable misstatement or deviation rate
Allowable sampling risk
Characteristics of the population

Question 179

requirements of audit sampling plans

Answer 179

Select sample items in such a manner that they can be expected to be representative of the population
Sample results should be projected to the population
Items that cannot be audited should be treated as misstatements or deviations in evaluating sample results
Nature and cause of misstatements or deviations should be evaluated

Question 180

other sample selection methods

Answer 180

haphazard selection, block selection, stratification

Question 181

haphazard selection

Answer 181

Select items on an arbitrary basis, without any conscious bias

Question 182

block selection

Answer 182

all items in a selected time period, numerical sequence or alphabetical sequence
Least desirable for use in control/substantiate testing; primaly use for fraud/ forensic investigations

Question 183

stratification

Answer 183

Technique of dividing population into relatively homogeneous subgroups

Question 184

advantages of classical variables sampling

Answer 184

when there are many misstatements in the population, it will result in a small sample size

items with zero and negative balances do not require any special treatment

sample size may be somewhat easier to expand if that becomes necessary

Question 185

disadvantages of classical variables sampling

Answer 185

to determine the sample size, the standard deviation of the population must be estimated

to evaluate results, the sample’s standard deviation must be calculated

it (especially means per unit) must be stratified, requiring a use of a computer to perform the computations

Question 186

advantages of monetary unit sampling (MUS)

Answer 186

the technique is generally easier to use

no estimate of the standard deviation of the population is needed

the technique automatically stratifies the population because items are selected based on their dollar amount

when there are few misstatements, the technique will generally result in a smaller sample size

sample selection can begin before the entire population is available

Question 187

disadvantages of monetary unit sampling (MUS)

Answer 187

special considerations are required to handle understated accounts and negative balances

each item in the population must have a book value

when misstatements are found, the technique might overstate the allowance for sampling risk

for accounts with a moderate number of misstatements, the sample size may exceed that of classical techniques

Question 188

audit risk =

Answer 188

inherent risk x control risk x detection risk

Question 189

audit risk

Answer 189

The allowable audit risk that a material misstatement might remain undetected for the account balance and related assertions

Question 190

inherent risk

Answer 190

the risk of a material misstatement in an assertion, assuming there were no related controls

Question 191

control risk

Answer 191

the risk that a material misstatement that could occur in an assertion will not be prevented or detected on a timely basis by internal control

Question 192

detection risk

Answer 192

the risk that the auditors’ procedures will fail to detect a material misstatement if it exists