Module 7: Audits

Question 1

5 flavors of audit opinions

Answer 1

1. Unqualified: financial statements are fairly stated and there are no explanatory paragraphs needed
2. Modified unqualified: unqualified but have an explanatory paragraph (e.g., discussing that company changed accounting principles or to emphasize a matter like the significant change in nature of the company’s activities)—not a big deal and not used to point out problems with company’s financial statements, except for “going concern” paragraph
3. Qualified: statements as a whole are okay but there is an accounting problem worth noting (e.g., departure from GAAP or inadequate FN disclosure)
4. Adverse: financial statements as a whole are screwed up—in reality company will find new auditors who think differently
5. Disclaimer: when CPA can’t form an opinion (e.g., CPA’s lack of independence or bc of an inability to gather evidence)

Question 2

audit opinion flavor #1: unqualified

Answer 2

financial statements are fairly stated and there are no explanatory paragraphs needed

Question 3

audit opinion flavor #2: modified unqualified

Answer 3

unqualified but have an explanatory paragraph (e.g., discussing that company changed accounting principles or to emphasize a matter like the significant change in nature of the company’s activities)—not a big deal and not used to point out problems with company’s financial statements, except for “going concern” paragraph

Question 4

audit opinion flavor #3: qualified

Answer 4

statements as a whole are okay but there is an accounting problem worth noting (e.g., departure from GAAP or inadequate FN disclosure)

Question 5

audit opinion flavor #4: adverse

Answer 5

financial statements as a whole are screwed up—in reality company will find new auditors who think differently

Question 6

audit opinion flavor #5: disclaimer

Answer 6

when CPA can’t form an opinion (e.g., CPA’s lack of independence or bc of an inability to gather evidence)

Question 7

Who can work on an audit?

Answer 7

anyone

Question 8

Who can sign an audit opinion?

Answer 8

only a CPA

Question 9

3 steps of becoming a CPA

Answer 9

(1) education (150 hours in most states)
(2) pass uniform 4-part exam
(3) experience req (0-2 years)

Question 10

Auditors gather evidence about whether the financial statements are reasonably stated by:

Answer 10

• Analytical review (e.g., comparing current year account balances to prior years to see if variations make sense)
• Inquiries of client (e.g., discuss with appropriate client personnel the reasons for significant variances identified in the analytical review procedures)
• Outside confirmation (e.g., sending letters to customers to verify the amount of A/R the client has recorded as being due from those customers)
• Tests of transactions (e.g., looking at warehouse reports for goods received from vendors to make sure the goods have either been paid for or that there’s an A/P recorded for the amount still owed on the goods
• Physical observation (e.g., counting the client’s inventory)
• Review of client’s internal control

Question 11

In reviewing a client’s internal control, CPAs find good internal control through:

Answer 11

• Adequate separation of duties (most important): Sarbanes-Oxley law reqs auditor to give opinion on company’s internal control
• Separation of control of company’s assets from the accounting (don’t let cashier do bookkeeping)
• Separation of authorization of company’s transactions from control of assets (person who authorizes payment of a bill shouldn’t also be writing the check)
• Separation of operational responsibility from the accounting (keep records at home office bc ppl at the plant might have incentive to change #’s)
• Separation of info technology duties/access from user depts: don’t let sales agent enter in customer order online (might override system to allow more of credit sale than what customer is authorized for)
• Proper authorization of transactions
• Proper documentation
• Physical control over assets and records (use of fireproof safes, safety deposit box, lock inventory storeroom)
• Performance of independent checks (e.g., someone preps bank reconciliations and someone else reviews)

Question 12

Adequate separation of duties, the most important factor that a CPA looks at in reviewing a client’s internal control involves:

Answer 12

• Separation of control of company’s assets from the accounting (don’t let cashier do bookkeeping)
• Separation of authorization of company’s transactions from control of assets (person who authorizes payment of a bill shouldn’t also be writing the check)
• Separation of operational responsibility from the accounting (keep records at home office bc ppl at the plant might have incentive to change #’s)
• Separation of info technology duties/access from user depts: don’t let sales agent enter in customer order online (might override system to allow more of credit sale than what customer is authorized for)