Transcript
AUD - Notes Chapter 1 http://www.cpa-cfa.org
Reports on Comparative Comparative Statements If the prior year’s financial statements were not audited and that the current year’s financial statements are being audited, the auditor aud itor is facing a scope limitation limitatio n (because the beginning be ginning balances may not no t be correct) and may require a disclaimer opinion. When updating (changing prior) periods the explanatory should disclose the: ! ate of the auditor’s pre"ious report # ! #pinion type pre"iously issued $ ! $eason for prior opinion % ! %hanges that ha"e occurred & ! &tatement 'opinionis different #nly #$%& change their mind *pdate or change opinion when now in conformity with +- (restate prior yr /&) $eport of a predecessor auditor ! presented 0he prior (old) %- should: $ead the current period statements %ompare the statements audited with the current period statements #btain a letter of representation from the successor auditor #btain a letter of representation from mgmt If the report is unre"ised use the original report date in any reissue If the report is re"ised dual date • • • • • •
$eport of a predecessor auditor ! not presented 0he current (new) %- should: 1ot name the predecessor auditor a uditor 0he date of the predecessors auditors report 0he type of opinion expressed by the predecessor auditor 0he substanti"e reasons for other than an unqualified report • • • •
Subsequent Events Events 0ype I e"ents ! conditions on or before balance sheet date, accrue, loo2ing bac2ward $equires a /& ad3ustment 0ype II e"ents ! conditions existing after the balance sheet date, disclose in footnotes, loo2ing forward 4ay require footnote disclosure uditors responsibility for subsequent e"ents ! -$I45 is included in yr end fieldwor2 - ! -ost balance sheet transactions $ ! $epresentation letter should be obtained from mgmt I ! Inquiry 4 ! 4inutes of stoc2holders, directors, and other committee meetings should be read 5 ! 5xamine latest a"ailable interim /&6 compare them with the /& under audit uditors responsibility after the original date of the auditors report 0he auditor has no acti"e responsibility. 7owe"er, if the auditor becomes aware of a subsequent e"ent, auditor must use professional 3udgement to decide whether to ad3ust the /& or disclosures If ad3usts are made after the original date of the auditors report, the auditor may dual date the report 5x. '8an, 9, 9;;;, except for 1ote 9, as to which the date is eb <, 9;;; 1
AUD - Notes Chapter 1 http://www.cpa-cfa.org
acts disco"ered after report is issued (the auditors missed it) uditor action d"ise client to issue re"ised /& or ma2e additional disclosures -ro"ide notification that the /& can not be relied upon If the client refuses to follow procedures 1otify the board of the directors d irectors issociate with the client Inform any regulatory agencies (if applicable) 1otify parties relying on o n the /& • •
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#mitted audit procedures disco"ered after submission of the audit program (we forgot to do it) uditor should determine whether other audit procedures tended to compensate for the omitted procedures pply the omitted procedures (or alternati"e procedures) • •
Reporting on Other Information Information uditor should perform limited procedures on supplementary information and report deficiencies = omissions . Inquire of mgmt 9. etermine if the methods uses are consistent with mgmt’s responses, audited /& and other 2nowledge <. %onsider whether the client representation letter should refer to the supplementary information &egment information is required by +4aterial misstatement ! +- problem qualified or ad"erse opinion &cope limitation ! +& problem qualified or disclaimer opinion When an auditor submits a document containing audited /& to a client or others, the auditor has a responsibility to report on all information in the document 0he auditor must indicate in the report whether the accompanying information is fairly stated in all material respects in relation to the basic /& ta2en as a whole. 0he report should also describe the character of the auditor examination and the degree of responsibility the auditor is assuming. %ondensed /& 0he uditor must indicate: 0hat the auditor audited and expresses an opinion on the complete /& ate of the auditors report on the complete /& 0ype of opinion expressed Whether the information in the condensed statements is fairly stated, in all material respects • • • •
&elected financial data 0he auditor must indicate whether the selected financial data is fairly stated, in all material respects, in relation to the /& from which it has been deri"ed. n accountants report should include . >rief description of the nature of the engagement 9. &tatement that the engagement was performed in accordance with I%- standards <. Identification specific entity, descriptions of the transactions, statement about the source of the information ?. statement describing the appropriate acctg principles (including country of origin) to be applied @. &tatement that mgmt is responsible A. statement that any differences in the facts, circumstances or assumptions may change the report B. $estrict use of report to mgmt, board of directors, prior and current auditors 2
AUD - Notes Chapter 1 http://www.cpa-cfa.org
acts disco"ered after report is issued (the auditors missed it) uditor action d"ise client to issue re"ised /& or ma2e additional disclosures -ro"ide notification that the /& can not be relied upon If the client refuses to follow procedures 1otify the board of the directors d irectors issociate with the client Inform any regulatory agencies (if applicable) 1otify parties relying on o n the /& • •
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#mitted audit procedures disco"ered after submission of the audit program (we forgot to do it) uditor should determine whether other audit procedures tended to compensate for the omitted procedures pply the omitted procedures (or alternati"e procedures) • •
Reporting on Other Information Information uditor should perform limited procedures on supplementary information and report deficiencies = omissions . Inquire of mgmt 9. etermine if the methods uses are consistent with mgmt’s responses, audited /& and other 2nowledge <. %onsider whether the client representation letter should refer to the supplementary information &egment information is required by +4aterial misstatement ! +- problem qualified or ad"erse opinion &cope limitation ! +& problem qualified or disclaimer opinion When an auditor submits a document containing audited /& to a client or others, the auditor has a responsibility to report on all information in the document 0he auditor must indicate in the report whether the accompanying information is fairly stated in all material respects in relation to the basic /& ta2en as a whole. 0he report should also describe the character of the auditor examination and the degree of responsibility the auditor is assuming. %ondensed /& 0he uditor must indicate: 0hat the auditor audited and expresses an opinion on the complete /& ate of the auditors report on the complete /& 0ype of opinion expressed Whether the information in the condensed statements is fairly stated, in all material respects • • • •
&elected financial data 0he auditor must indicate whether the selected financial data is fairly stated, in all material respects, in relation to the /& from which it has been deri"ed. n accountants report should include . >rief description of the nature of the engagement 9. &tatement that the engagement was performed in accordance with I%- standards <. Identification specific entity, descriptions of the transactions, statement about the source of the information ?. statement describing the appropriate acctg principles (including country of origin) to be applied @. &tatement that mgmt is responsible A. statement that any differences in the facts, circumstances or assumptions may change the report B. $estrict use of report to mgmt, board of directors, prior and current auditors 2
AUD - Notes Chapter 1 http://www.cpa-cfa.org
$eporting on /& prepared for use in other countries istribution outside *.&. only: auditor may use either C 0he report of the other country C *& style report modified to the accounting principles of another country istribution within the *&: auditors report should be the *& standard report modified as appropriate for departures from f rom *& +-.
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Quality Control Standards 0he fi"e interrelated elements of quality control are: ! cceptance and continuance of client’s engagement I ! Independence, integrity and ob3ecti"ity % ! %ontinuous monitoring - ! -ersonnel management ! ssurance regarding engagement performance Acceptance and continuance of clients and engagements • %onsiders the ris2 associated with clients (don’t accept a client whose mgmt lac2s integrity) • *nderta2es only those engagements that the firm can reasonably expect to complete with professional care Independence, integrity and objectivity • -olicies and procedures which help maintain personnel independence in fact and appearance • Dead partner and the re"iewing partner must rotate off the audit e"ery fi"e years • $outine tax return preparation, tax planning and employee personal tax ser"ices are allowed under &arbanesC#xley but must be appro"ed by the audit committee in writing Continuous monitoring • What the title implies -eer re"iew C #ne %- firm re"iews another %- firms quality control system, occurs e"ery < years for a %- firm that is a member of the I%-. C -urpose is to determine and report whether %- firm being re"iewed has de"eloped adequate policies and procedures for quality control and they are following them C *pon completion, a report is issued with conclusions and recommendations Personnel Management • %riteria for hiring, assignment of the firms personnel to engagements, professional de"elopment and ad"ancement Assurance regarding engagement performance • -olicies and procedures that assure that the engagement wor2 meets professional standards, regulatory requirements, and the firms own standards of quality
+& relate to the conduct of each indi"idual engagement, whereas quality control relate to the conduct of all professional acti"ities of the firms practice as a whole 0he quality control standards of a firm affect both the performance of each audit and the performance of the audit practice as a whole eficiencies in a firm’s quality control do not necessarily mean/indicate a lac2 of +& compliance.
Other Engagements, Reports and Accounting Services uditing standards ha"e restricted special reports to the following @ areas . #%># ! use of other comprehensi"e basis of accounting /& (cash basis, priceCle"el ad3usted /&) 0he use of nonC+- requires the auditor to issue either a qualified or ad"erse opinion unless the nonC+method is an #%># (in which case an unqualified opinion is appropriate)
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2. Specific elements, accounts or items of a FS ! 0he auditor expresses an opinion on each of the specified elements, if the element is farCreaching or per"asi"e (1I, &0E 5F, or any item based thereon) the auditor must audit the complete set of financial statements. piecemeal opinion may be expressed if the items do not constitute a ma3or portion of the /&. piecemeal opinion cannot be issued if the auditor has expressed a disclaimer or ad"erse opinion. !. Issue special report on a clients compliance "it# contractual agreements or regulatory re$uirements uditor must ha"e audited the /& and may only issue negati"e assurance. %annot be issued if the auditor has expressed a disclaimer or ad"erse opinion. Dimitedly distributed %. Special purpose financial presentations to comply "it# contractual agreements or regulatory provisions
@. Financial information presented in prescribed forms or sc#edules ! the auditor may attest to the fairness on financial information presented in prescribed forms such as loan applications or regulatory filings. 0he auditor may ma2e modifications to an unqualified special report by adding an explanatory paragraph after the opinion paragraph
Compilation and Revie of !inancial Statements %-’s can perform two le"els of ser"ice (compilation and re"iew) with respect to unaudited /& of a nonCpublic company. Compilation engagement ! 1o assurance or opinion. %- does not perform any audit or re"iew procedures. A &evie" ! Dimited (negati"e) assurance. %- performs inquiry and analytical procedures
When a %- performs more than one ser"ice (such as complication and an audit) the %- should issue a report that is appropriate for the highest le"el of ser"ice rendered. n engagement letter is recommended but not required &tatements on &tandards for ccounting and $e"iew &er"ices ! pronouncements issued by the accounting and re"iew ser"ices committee of the I%- compilation engagement may in"ol"e compiling and reporting on only one financial statement 0he compilation engagement report should include: D$ ! &tatement that a compilation has been performed in accordance with &&$& issued by the I%- D ! &tatement that a compilation is limited to presenting, in the form of /&, information that is the representation of mgmt ! &tatement that the accountant has not audited the /& $ ! &tatement that the accountant has not re"iewed the /& ! isclaimer of opinion and a statement that the accountant gi"es no assurance on the /& Gou’re D$ when all you do is compile /& %ompiled /& that omit +- disclosures are acceptable if: $eason for omission was not to decei"e user %ompilation report warns user of missing disclosures • •
%ompilation with limited disclosures are labeled '&elected Information ! &ubstantially ll isclosures $equired >y +- re 1ot Included 5
AUD - Notes Chapter 1 http://www.cpa-cfa.org
n opinion, e"en qualified or ad"erse, requires and audit. When an accountant performing a compilation or re"iew becomes aware of a +- departure, the report should be modified or the %- with withdraw from the engagement. n opinion would not be expressed n accountant who submits unaudited /& to the client that are not expected to be used by a third party may use an engagement letter rather than a compilation report $e"iew of /& ! a higher le"el of ser"ice than compilation because it results in an expression of limited assurance. $e"iews include inquiry and analytical procedures. 7owe"er, no required to obtain an understanding of internal control or assess control ris2 n auditor is required to perform these in a $e"iew: * ! *nderstanding with client must be established D ! Dearn and or obtain sufficient 2nowledge of the entity’s business I ! Inquires ! nalytical procedures $ ! $e"iew, other procedures % ! %lient representation letter required from mgmt (don’t need with a compilation) - ! -rofessional 3udgement should be used ! uditor should communicate results 0he ob3ecti"e of a re"iew of financial information is to determine whether material modifications are necessary for the information to be in conformity with +-. 1ot required to communicate with predecessor auditor 4a2e inquires of internal personnel, not external people or entities. %lient representation letter from mgmt is required which co"ers all /&’s and periods co"ered by the re"iew report udit test wor2, including testing internal controls, is not performed 0he accountants report in a re"iew engagement should include: ! the re"iew has been performed in accordance with &&$& standards established by the I%- 4 ! ll /& information is the representation of mgmt I ! a re"iew consists principally of inquiries of company personnel ! a re"iew consists of analytical procedures applied to financial data & ! a re"iew is substantially less in scope than an audit 1 ! no opinion is expressed 4 ! accountant is not aware of any material modifications that should be made to the /& in order for them to be in conformity with +4 I &14
Reporting on Comparative !"S When the continuing auditor performs a higher le"el of ser"ice (ser"ice upgrade) in the current period, the report on the prior period should be updated and issued as the last paragraph of the current period’s report owngrade in ser"ice (last yr we re"iewed, this yr we compile). Issue a compilation report and add a paragraph to describe prior period responsibility assumed. #r issue both a re"iew report and compilation report
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Whene"er prior accountants are as2ed to reissue a prior report (audit, re"iew or compilation) they should reas the new /& and obtain a representation letter from the new accountant $eporting when one period is audited $eissue the prior period report, or Include an additional paragraph in the current report describing the responsibility assumed for the prior period statements • •
Revie of Interim !inancial Information In an initial re"iew of interim financial information, the accountant should ma2e inquires of the predecessor auditor, and if allowed, re"iew the predecessor’s documentation Inquiry of clients lawyer is not required but may be appropriate in certain circumstances +oing concern is not required but may be appropriate Di2ely misstatement ! best estimate of the total misstatement in an account balance or class of transactions. 0he accountant should: ccumulate all such estimates for further e"aluation %onsider that the aggregated effect of se"eral immaterial misstatements 5"aluate potential effect on current and future periods • • •
re"iew of interim /& of a public company is conducted in accordance with I%- auditing standards not &&$& &hould modify their report if, during the re"iew, they become aware of a departure from ++oing concern no modification if disclosed Dac2 of %onsistency no modification if disclosed
#etters for $nderriters comfort letter is a letter from the %- to the named underwriter. It co"ers the period from the date of the last auditors’ report to the 'effecti"e date of the registration. When a comfort letter is issued, the %- is required to perform a re"iew of interim financial information in accordance with auditing standards 0o obtain a comfort letter, parties other than the names underwriter must pro"ide the %- with an attorney’s opinion or representation letter, confirming that such a party has a 'due diligence defense %omments in a comfort letter a limited to: inancial info expressed in dollars, and inancial info deri"ed from accounting records • •
comfort letter is solely to assist the underwriters in conducting and documenting their in"estigation of the company in connection with the offering -ro"ide positi"e assurance on: 7
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%-’s independence %ompliance of the /& with the &5% ct, assuming the /& are audited
-ro"ide negati"e assurance on: *naudited /& ! if a re"iew has not been performed, procedures performed and findings obtained should be listed %hanges in selected financial information during subsequent period Whether nonCfinancial data in the registration statement complies with regulation &CE •
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Attest Engagements Attest engagements ! %- is engaged to issue or does issue an examination, a re"iew, or an agreedCupon procedures report on sub3ect matter, or an assertion that is the responsibility of another party (usually mgmt). 4a3or attest ser"ices: • greedCupon procedures • inancial forecasts and pro3ections • -ro forma /& • Internal control o"er financial reporting
0he following standards apply to ser"ices a %- may offer: udit engagements ! && (&tatements on uditing &tandards) %ompilation and re"iew engagements ! &&$& (&tatements on &tandards for ccounting and $e"iew &er"ices) ttest engagements ! &&5 (&tatements on &tandards for ttest 5ngagements) &&5 does not apply to: -ro"iding consulting/ad"isory ser"ices #perational audits (usually performed by internal auditors) • •
0here are attestation standards: 0I--G -5 %$& +eneral &tandards ! 0I--G 0 ! 0raining and proficiency I ! Independence - ! -erformance/due professional care in planning and performance - ! -rofessional 2nowledge of sub3ect matter G ! Gour belief that the assertion and the criteria is ob3ecti"e, measurable and complete ield wor2 &tandards ! -5 - ! -lanning and super"ision 5 ! 5"idence to pro"ide reasonable basis for the conclusion $eporting &tandards ! %$& ! ssertion or sub3ect matter should be identified % ! %onclusions should be expressed $ ! $eser"ations or unresol"ed issues should be disclosed & ! &tatement restricting use of the report to specified parties should be included (if necessary) Agreed'upon procedures ! %- is engaged to issue a report of findings based on specific agreed upon procedures (example is mutual fund performance). greed upon procedures may be performed is the following conditions exist: I ! Independence of the practitioner ! greement of the parties 4 ! 4easurability and consistency 8
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& ! &ufficiency of the procedures * ! *se of the report is restricted to the specified parties $ ! $esponsibility for the sub3ect matter rests with the client 5 ! 5ngagements to perform agreed upon procedures on prospecti"e financial statements I 4 &*$5 you can perform these agreed upon procedures Financial forecasts ! the expected financial results of a future period, based on expected conditions (i.e. budget) Financial projection ! financial results based on a 'what if scenario, based on hypothetical assumptions
orecasts and pro3ections are two types of prospecti"e /&. -ro forma /& are different, because it shows what past financial results of an expired period would ha"e been if something had been different. #nly a financial forecast is appropriate for general use. While both, forecasts and pro3ections are appropriate for limited use. %ompilation of prospecti"e /& ! the proper assembling of financial data based on the party’s assumptions 1o assurance of any 2ind gi"en 0he practitioner is not required to gather supporting e"idence &ignificant assumptions must be disclosed otherwise cannot issue compilation • • •
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%lanning and Supervision 0I- -I5 %# 0he audit committee is responsible for the selection and the appointment of the auditor and the re"iewing the nature and scope of the engagement In a new client relationship, it is mandatory to ma2e inquiries of the predecessor auditor. %lient permission is needed. If the client is unwilling it is a scope limitation. >efore accepting the client, inquiry the old %- regarding: Information that may re"eal mgmt integrity isagreements with mgmt (accounting principles, auditing procedures) $easons for change of auditor %ommunication to the audit committee regarding fraud, illegal acts, internal control matters fter acceptance, inquiry the old %- regarding: 4a2e specific inquiries about the audit $e"iew predecessors audit documentation (wor2papers) • • • •
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-reliminary 5ngagement cti"ities ssess the integrity of mgmt ssess the a"ailability and adequacy of the clients accounting records (lac2 of records H scope limitation) 5"aluate the firm’s quality control policies and procedures • • •
An engagement letter ! a signed contract which documents the understanding with the client is required for an audit engagement (should be signed and dated by the client)
4anagement’s is responsible for: 0he /& Internal controls %ompliance with laws $epresentation letter (letter to auditor at end of the engagement that confirms the representation made) • • • •
uditor is responsible for: %onduct the audit in accordance with +& (obtain reasonable assurance about whether the /& are free from material misstatements •
n audit is not designed to detect error or fraud that is immaterial to the /& n audit is not designed to pro"ide assurance on internal control or to identify significant deficiencies udit is sub3ect to inherent ris2s that errors and fraud will not be detected. If we disco"er fraud then we report it to the audit committee -lanning the udit 0he nature, extent and timing of planning procedures will "ary based on the engagement (the 150 we cast o"er the audit) 0he auditor is required to obtain an understanding of the entity, its en"ironment and internal controls #btain 2nowledge about the clients industry and business through: udit guides, trade publications and public information •
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0our client facilities $e"iew financial history of client #btain understanding of client accounting Inquire of client personnel
nalytical -rocedures used for: or planning the nature, extent, and timing of other audit procedures (required) &ubstanti"e tests to obtain e"idential matter (optional) #"erall re"iew in the final stage of the audit (required) • • •
nalytical procedures performed during planning *sed to enhance the auditors understanding, and identify unusual transactions, e"ents and amounts uring planning, analytical procedures consist of a re"iew of data aggregated at a high le"el, such as comparing financial statements to budgeted amounts inancial data is used through rele"ant nonfinancial data (number of employees, square footage) • •
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0he audit plan 4ust be written &pecific audit procedures are documented escription of the nature, extent, and timing of: C -lanned ris2 assessment procedures (assess ris2 of material misstatement) (required) C -lanned further audit procedures 0iming of audit procedures should be discussed with mgmt • • •
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4ateriality (no"n misstatements ! specific misstatements identified during the audit )i*ely misstatements ! misstatements the auditor considers li2ely to exist due to differences between auditor and mgmt 3udgements or from audit e"idence +olerable misstatements ! maximum error in a specific population that the auditor is willing to accept
ll misstatements must be communicated to mgmt >ecause the /& are interrelated, the auditor should use the smallest le"el of misstatement that could be material to any one of the /& 0he auditor must consider the effects, both indi"idually and in aggregate, of the uncorrected misstatements (both 2nown and li2ely) 4isstatements are more li2ely to be considered if they: ffect trends in profitability ffect’s entity’s compliance with loan co"enants, contracts or regulatory pro"isions Increase mgmt’s compensation ffect significant /& elements %an be ob3ecti"ely determined • • • • •
0he auditor should document: -lanning le"els of materiality and tolerable misstatement, the basis for those le"els and any subsequent changes •
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Enown and li2ely misstatements that were corrected by mgmt summary of uncorrected misstatements (2nown and li2ely), auditors conclusions on whether those misstatements cause the /& to be materially misstated, and the basis for the conclusion ocumentation of uncorrected misstatements should include: &eparate identification of 2nown and li2ely misstatements 0he aggregate effect on the /& $ele"ant qualitati"e factors affecting materiality 3udgements • •
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udit $is2 udit ris2 is the ris2 that the auditor may un2nowingly fail to modify appropriately the opinion on the /& that are materially misstated (ris2 that the auditor will gi"e the wrong opinion) $ H $44 $ $ H (I$ %$) $ udit ris2 ($) should be low &is* of Material Misstatement &MM ) ! assessed by auditor and is independent of /& audit In#erent ris* I&- ! susceptibility of a rele"ant assertion to a material misstatement, assuming there are no related controls (mista2e in the clients acctg system). uditor assesses I$ but can’t change Control ris* C&- ! ris2 that a material misstatement could occur in a rele"ant assertion will not be pre"ented or detected on a timely basis by the clients internal controls (clients internal control does not catch it) etection ris* &- ! ris2 that the auditor will not detect a misstatement that exists within a rele"ant assertion (auditor will miss the mista2e). etection ris2 is a function of the effecti"eness of audit procedures. 0he auditor can change the detection ris2 $44 and $ ha"e in"erse relationship. When ris2 of material misstatement is high, detection ris2 should be set low (so we ha"e to do more wor2) &ubstanti"e procedures are always required irect relationship between $44 and assurance required from &ubstanti"e procedures. +reater the ris2 ($44) the more persuasi"e e"idence needed. udit ris2 and materiality must be considered at both the /& le"el and the account balance (item le"el) t the /& le"el, the auditor should consider ris2s that ha"e per"asi"e effect on the /&, potentially affecting many rele"ant assertions 0he account balance le"el (transaction = item le"el) is used to determine the nature, extent, and timing of audit procedures. In"erse relationship between audit ris2 and materiality •
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udit -rocedures: . $is2 assessment procedures 9. 0est of controls ! test of internal controls (%$I45) <. &ubstanti"e procedures ! tests J balances /& ssertions (made by mgmt) 0ransactions and e"ents % ! %ompleteness - ! -roper period cutoff ! ccuracy % ! %lassification # ! #ccurrence 12
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ccount balances % ! %ompleteness ! llocation and "aluation $ ! $ights and obligations 5 ! 5xistence -resentation and disclosure % ! %ompleteness * ! *nderstandability and classification $ ! $ights and obligations K ! Kaluation and accuracy fter sufficient planning information has been gathered, an audit plan should be drafted. written audit plan is required for e"ery audit. When planning the audit, the auditor should consider the extent of in"ol"ement of the client’s internal auditors in the audit. Internal auditors are not independent, thus, the external auditor can’t share with the internal auditor any responsibility for audit decisions. uditor must obtain an understanding of the internal audit function If the auditor uses the wor2 of internal audit, competence and ob3ecti"ity must be assessed 0he higher the le"el the internal auditors report to, the more ob3ecti"ity can be assumed 0he auditor remains solely responsible for the report on the /&. 0he internal auditor may not be utiliLed to ma2e 3udgement calls • • • •
If a specialist is used must e"aluate the competence and ob3ecti"ity of the specialist. 0reat li2e one of your staff.
!raud and Illegal Acts /rrors ! unintentional Fraud ! intentional6 9 types . raudulent financial reporting (lying) ! designed to decei"e /& users. *sually in"ol"e manipulation, misrepresentation, intentional misapplication of accounting principles 9. 4isappropriation of assets (stealing) ! theft of an entities assets
raud ris2 factors include: Incenti"es/pressures: a reason to commit fraud #pportunity: lac2 of effecti"e controls $ationaliLation/attitude: an attempt to 3ustify fraudulent beha"iour • • •
Its mgmt’s responsibility to design and implement programs and controls to pre"ent and detect fraud 0he auditor has a responsibility to plan and perform (referred to as design) the audit to obtain reasonable assurance about whether the /& are free from material misstatement, whether caused by error or fraud. 4gmt o"erride of controls is a ma3or factor in fraud. Inquire entire personnel regarding their "iews of fraud ris2 C Inconsistent responses indicate a need for additional e"idence %onsider the results of analytical procedures (required during the planning and final stage) 13
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ttributes of ris2: 0ype of ris2: fraudulent /& or misappropriation of assets &ignificance of ris2: can it lead to a material misstatement Di2elihood of the ris2: how li2ely is this to happen -er"asi"eness of the ris2: does it affect the whole /& or only specific accounts or transactions 9 reas of greatest fraud concern: . Improper re"enue recognition 9. 4gmt o"erride controls • • • •
Items are more susceptible to manipulation when they in"ol"e: . 7igh degree of mgmt 3udgement and sub3ecti"ity 9. 7ighly complex accounting principles 0he auditor is required to respond to the results of the ris2 assessment on three le"els . #"erall, general response C assigning personnel to the engagement C determining the appropriate le"el of super"ision of engagement personnel C e"aluating mgmt’s selection and application of accounting principles 9. $esponse encompassing specific audit procedures C change nature C change extent C change timing <. $esponse addressing ris2s related to mgmt o"erride C examine 3ournal entries and other ad3ustments C re"iew accounting estimates for biases C e"aluate the business purpose for significant unusual transactions &ignificant fraud ris2 ! may consider withdrawing from the engagement $e"enue recognition C perform substanti"e analytical procedures relating to re"enue C confirm with customers contract terms and the absence of side agreements $e"enue recognition criteria . must ha"e an arrangement (signed agreement) 9. must be a deli"ery <. must be fixed or determinable price ?. collectability In"entory quantities C concern that there may be a failure to reconcile boo2s to physical in"entory 4gmt estimates C engage a specialist C de"elop an independent estimate C perform a retrospecti"e re"iew of prior period estimates (how good were last yr’s estimates) 4isstatements caused by fraud (e"en immaterial misstatements) may be indicati"e of an underlying problem with mgmt integrity. 0he auditor may need to ree"aluate the assessment of fraud ris2, the assessed effecti"eness of controls, and the appropriateness of audit procedures applied. Inform the audit committee of any fraud. -arties outside the entity that we may communicate with in certain circumstances: 14
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C to comply with certain legal and regulatory requirements C to a successor auditor C in response to a subpoena C to a funding agency %omplete documentation of the auditors ris2 assessment and response is required If the auditor has not identified improper re"enue recognition as fraud ris2, support for this conclusion Illegal acts ! "iolation of law 0he auditors responsibility to detect illegal acts are the same for fraud and errors. 0he auditor has no obligation to loo2 for illegal acts ha"ing an indirect effect on the /& 0he auditor generally does not include procedures to specifically detect illegal acts 5ffect of illegal acts on the auditors report eparture from +- ! 'expect for or ad"erse Insufficient e"idence ! 'except for or disclaimer %lients refuses to modify report ! withdraw
Ris& Assessment 0I- -I5 %# (fieldwor2) udit &teps I4%- I ! Internal control, understand 4 ! 4aterial misstatement, assess ! ssess ris2 control % ! %ontrol testing - ! -erform substanti"e testing ! udit e"idence, e"aluate appropriateness and sufficiency I C Internal control ! obtain an understanding of the entity and its en"ironment $is2 assessment procedures Inquires nalytical procedures (required for planning and final stages) #bser"ation and inspection iscussion among audit team #ther procedures 0he auditor may choose to perform substanti"e procedures or tests of controls, if its efficient to do so actors to understand Industry, regulatory, and other external factors 1ature of the entity #b3ecti"es, strategies and business ris2s C >usiness ris2s ! e"ents or circumstances that could ad"ersely affect the firm (ie competition) inancial performance Internal controls and accounting policies • • • • • •
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4 ! 4aterial misstatement, assessing the ris2s actors that my be indicati"e of significant ris2s *nusual, complex transactions >usiness ris2s raud ris2 • • •
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&ignificant related party transactions 7ighly sub3ecti"e accounting estimates and principles $esponse to significant ris2s 5"aluate the design of the entity’s related controls etermine whether the controls ha"e been implemented 5"aluate whether and how mgmt responds to such ris2s • •
• • •
0est of controls ! test strengths to be relied upon, not wea2nesses %ontrols that are more directly related to an assertion are more effecti"e in pre"enting, detecting and correcting a misstatement in that assertion, than controls which only relate indirectly to an assertion. ocumentation requirements iscussion among the audit team Eey elements of the understanding of the entity and its en"ironment 0he assessment of the ris2s of material misstatement 0he identified ris2s and related controls e"aluated by the auditor • • • •
ocument . control factors that were used/helped to plan the audit engagement 9. control factors that helped ensure mgmt rules and directi"es were followed orms of documentation may include any item the auditor can I1 ! lowchart I ! Internal control questionnaire or chec2lists 1 ! 1arrati"e ! ecision table lowcharts ! symbolic diagram representing the sequential flow of authority, processes and documents. epicts the auditors understanding of the system n adequate flowchart shows the origin of each document in the system, its subsequent processing, and its final disposition I0 flowcharts are initially created to document the logic and existing flow of a computer program •
•
Internal control questionnaires ! used for each item of mgmt assertions 1arrati"es ! a narrati"e is a written "ersion of a flow chart (hard to 'see wea2nesses ecision tables or trees ! graphic illustrations that depict the logic of an operation or a process flowchart is sequential while a decision table/tree is logical
Internal Control 0I- -I5 %# 5ntity ob3ecti"es . $eliability of financial reporting (most rele"ant to the audit) 9. 5ffecti"eness and efficiency of operations <. %ompliance with applicable laws and regulations
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%ontrols that pertain to the first ob3ecti"e (reliability of financial reporting) are the most rele"ant to the audit, and these are the controls that the auditor must consider and understand. i"e components of internal controls ! %$I45 % ! %ontrol en"ironment: o"erall tone of the organiLation $ ! $is2 assessment ! mgmt’s identification of ris2 I ! Information and communication systems 4 ! 4onitoring: assessment of internal controls o"er time 5 ! 5xisting control acti"ities: control policies and procedures It’s a %$I45 not to ha"e strong internal controls %ontrol testing H internal controls (%$I45) &ubstanti"e testing H J balances 0he auditor should obtain an understanding of %$I45 as it pertains to financial reporting: . e"aluate the design of rele"ant controls and determine whether then ha"e been implemented 9. assess the ris2 of material misstatement <. design the nature, extent and timing of further audit procedures (%- tests internal controls in order to adequately plan the 150 audit) Dimitations of internal controls 7uman error %ollusion 4gmt o"erride &egregation of duties may be difficult to achie"e in a smaller entity • • • •
I0 system may ma2e it impossible to reduce detection ris2 through substanti"e testing alone (must do control testing as well) I0 benefits: bility to process large "olumes of transactions accurately Impro"ed timeliness and a"ailability of information acilitation of data analysis and performance monitoring $eduction is the ris2 that controls will be circum"ented 5nhanced segregation of duties through effecti"e security controls • • • • •
I0 $is2s: -otential reliance on inaccurate systems *nauthoriLed access to data *nauthoriLed changes to data, systems and programs ailure to ma2e required changes and updates to systems or programs • • • •
uditor should document use of programs and perform tests more often during the yr #rganiLational structure of the I0 department % ! %ontrol group ! responsible for internal control within I0 dept. # ! -rogram #perators ! input data - ! -rogrammers ! write and de"elop computer programs ! &ystem nalysts ! design the o"erall program, while programmers do the detailed wor2 D ! Dibrarian ! maintains the storage of the data 17
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nyone doing for an 3ob or super"ising another area is a wea2ness %$I45 % ! %ontrol 5n"ironment ! has per"asi"e effect on the auditors ris2 of assessment and preliminary 3udgements about its effecti"eness may influence 150 of further audit procedures to be performed &ets the tone of an organiLation, influencing the control consciousness of its people %ommunication and enforcement of integrity and ethical "alues 4gmt’s philosophy and operating style #rganiLational structure ssignment of authority, responsibility and accountability 7uman resource policies and practices • • • • • •
$ ! $is2 assessment %- should obtain understanding and 2nowledge •
I ! Information and communication %- should obtain understanding and 2nowledge ccounting process (automated and manual), from initiation of a transaction to /& ccounting records (electronic and manual) supporting information and specific accounts in"ol"ed in initiating, authoriLing, recording, processing and reporting transactions 0he financial reporting process, including the de"elopment of significant accounting estimates and the inclusion of appropriate disclosure • • •
•
4 ! 4onitoring %- should obtain understanding and 2nowledge -rocess that assesses the quality of internal control performance o"er time 5stablishing and maintaining internal control is a responsibility of mgmt • • •
5 ! 5xisting control acti"ities %ontrol acti"ities in a strong internal control system ha"e -I 0I-& - ! -renumbering of documents ! uthoriLation of transactions I ! Independent chec2s to maintain asset accountability ! ocumentation 0 ! 0imely and appropriate performance re"iews I ! Information processing controls ! ensure that transactions are "alid, authroriLed, and accurate C pplication controls ! controls for processing of indi"iduals transactions C +eneral controls ! apply to information processing throughout the company - ! -hysical controls for safeguarding assets ! simply security & ! &egregation of duties ! client should separate: A&C C uthoriLation C $ecord2eeping C %ustody of related assets 0he internal control en"ironment should be detected in the ordinary course of business by an employee, not C %ollusion C 4gmt o"errides or internal controls the auditor should #btain the necessary understanding of the user organiLations internal control to plan the audit ssess the control ris2 at the user organiLation, and • •
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-erform substanti"e procedures
$eport on controls placed in operation ! may aid the auditor in obtaining an understanding of controls, howe"er, it is pro"ided when tests of operating effecti"eness were not performed, and therefore it does not pro"ide the user with a basis for reducing the assessment of control ris2
Responding to Assessed Ris&s I4%- udit approach ! the auditors specific approach to identified ris2s at the rele"ant assertion le"el may consist of either a substanti"e or combined approach *se substanti"e approach when: %ontrols are not strong for an assertion 1ot cost/benefit to test the effecti"eness of the controls • •
%ombined approach ! both control testing and substanti"e procedures are used. If controls are operating effecti"ely, less assurance will be required from substanti"e procedures. 0est of controls may be required in highly electronic en"ironments, substanti"e procedures alone may not be sufficient
&tatus of internal control 1one or wea2 &ome &trong
udit approach $is2 le"el -erform control tests -erform substanti"e tests high 1o (because nothing to rely on) yesCmaximum medium Ges low Ges minimal (but ne"er eliminate for material balances, transaction classes, or disclosures)
0est of %ontrols C I4%- 0est of controls are performed when the auditors ris2 assessment is based on the assumption that controls are operating effecti"ely, or when substanti"e procedures alone are insufficient. (test control strengths, not wea2nesses) #btaining an understanding of internal controls includes e"aluating the design of controls and determining whether they ha"e been implemented #nly controls that are suitably designed to pre"ent or detect material misstatements are sub3ect to tests of operating effecti"eness Inspect client records documenting use and changes to I0 programs 1ature of tests of controls 0ests of operating effecti"eness of controls include: inquiries, inspection, obser"ation, and reperfornance s the planned le"el of assurance (about operating effecti"eness) increases, the auditor should obtain more reliable or more extensi"e audit e"idence • •
5"idence hierarchy: . -ersonal obser"ation and 2nowledge 9. 5xternal e"idence 19
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<. Internal e"idence ?. #ral e"idence 0iming of tests of controls When tests of controls are performed at one particular time, they pro"ide e"idence that controls operated effecti"ely only at that time. %ontrols tested throughout the period pro"ide e"idence of operating effecti"eness during that period %ontrols that are tested only during an interim period should be supplemented by additional e"idence for the remaining period (roll forward) If controls ha"e changed since they were last tested, operating effecti"eness must be retested in the current period 5"en if controls ha"e not changed, operating effecti"eness must be tested at least one e"ery third year -erform substanti"e testing ! I4%- *sed to detect material misstatements at the rele"ant assertion le"el &ubstanti"e procedures should be designed to be responsi"e to assessed ris2s, howe"er, regardless of the assessed ris2, substanti"e procedures are required for each material transaction class or account balance •
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9 types of substanti"e procedures . 0est of details ! applied to transaction classes, account balances and disclosures. J balances, ratios 9. &ubstanti"e analytical procedures ! used for large "olume predictable transactions irectional testing 0o test existence or occurrence assertion ! 0op down, start from /&. Doo2 for support H "ouching 0est existence for o"erstatement of assets and re"enues 0o test completeness assertion ! >ottom up, start from item, loo2 to see its included/co"ered in /& H tracing 0est completeness for understatement of liabilities and expenses If substanti"e procedures are performed at an interim date, the auditor should perform further substanti"e procedures (maybe with test of controls) to pro"ide reasonable basis for extending audit conclusions to period end If ris2 of material misstatement is low, performing substanti"e procedures at interim increases the ris2 that the auditor will not detect material misstatements in the /& In certain situations, such as those in which there is an identified fraud ris2, the auditor may choose to perform substanti"e procedures at or near period end. udit e"idence, e"aluate appropriateness and sufficiency ! I4%- udit e"idence obtained may cause the auditor to modify this or her initial ris2 assessment 0he auditor should not assume that an identified instance of fraud or error is an isolated occurrence When there is a change in the assessed le"el of ris2, the auditor should modify planned procedures accordingly 0he auditor uses 3udgement to e"aluate the sufficiency and appropriateness of audit e"idence • • •
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'ransaction Cycles 0I- -I5 %# ! whole chapter ? $e"enue cycle ! includes sales re"enues, recei"ables and cash receipts &ales (serially number documents are -I 0I-) . -reparation of sales order ! a serially numbered sales order is prepared and sent to the credit department for appro"al 9. %redit appro"al ! "aluation assertion, credit department determines ($%) <. &hipment ! &hipping department prepares a serially numbered bill of lading ($%) ?. >illing ! >illing dept. prepares serially numbered sales in"oice. &hipping documents, sales orders, and in"oices are compared to ensure that all shipments were based on customer orders and properly billed. 0he in"oice is then sent to the customer and /$ dept. ($%) @. ccounting ! the sale is entered into the sales 3ournal and a recei"able is recorded ($%) ccounts recei"able . &ales 9. %ollection of cash receipts <. *ncollectible recei"ables ! an aging schedule is prepared and sent to the credit department for use in carrying out its collection program. uditor obser"es the preparation of aging schedule to support assessing control ris2 below maximum ?. &ales returns ! a serially numbered recei"ing report may be used as a sales return slip. #nce the return is appro"ed, the related recei"able is eliminated %ash receipts . %ollection ! incoming mail must be opened by a person who does not ha"e access to the /$ ledger. #ne receipt copy should be sent to cashier (or treasury) for ban2 deposit. nother copy sent to /$ dept. for entry into the /$ subsidiary ledger. third copy should be sent to acctg dept. for entry into the general ledger 0esting controls for &ales Inquire about credit procedures for new customers ("aluation) ($%) %ompare sales 3ournal to subsidiary ledgers Inspect a sample of prenumbered shipping documents and C agree to sales order (existence) C account for prenumbered (completeness) Kouch a sample of sales in"oices, trace a sample of shipping documents Inspect customer exception file and disposition (existence, completeness, rights and "aluation) &end confirmations ! follow up on error reports (rights and obligations) 0est cutoff 0est adequacy of uncollectible accounts • • •
• • • • •
5xpenditure cycle -urchases . -urchase requisition ! the dept. needing an asset or ser"ices sends an appro"ed serially numbered requisition to the purchasing dept 9. -urchase orders ! obtain competiti"e bids from "arious suppliers to ma2e sure that the best price is obtained. *se prenumbered purchase orders <. $eceipt of goods or ser"icesC it is preferable that the copy not indicate the quantity ordered (blind copy), thus the recei"ing dept is forced to count the goods upon arri"al
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ccounts payable . record the payable 9. appro"e the bill ! when the in"oice arri"es, the accounting department appro"es it by matching the in"oice, purchase order, recei"ing report, and (sometimes) the requisition %ash disbursements . best for internal controls to pay in"oices by chec2 9. best for internal control to segregate appro"ing payment and writing chec2s <. 0reasurer pays the bills 0he accounting department has three functions . to record the payable 9. to appro"e the in"oice for payment <. to record the payment after its paid by the treasurer
0he auditor should re"iew bills in 8anuary to determine is they were incurred in 1o" or ec (search for unrecorded liabilities. udit procedures related to cash Internal controls o"er the handling of cash is one the most critical areas of an audit6 proper segregation of duties 0he auditor should obtain cutoff ban2 statements used to test for lapping and 2iting Kouch postings to ledger accounts, reconcile ban2 statements, and "erify cash transactions •
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&imultaneously "erify internal and external e"idence Internal e"idence ! includes counting cash on hand and reconciling it with the 3ournals 5xternal e"idence ! includes confirming accounts on deposit with ban2s, all securities on deposit and obtaining ban2 cutCoff statements )apping ! theft of cash is often concealed by failing to account for cash receipts (today’s cash receipts co"er yesterday’s theft) • >est way to guard against lapping is to use a loc2 box system. Inspect chec2s when deposited/cashed and compare to when accts recei"able was boo2ed
Eiting ! when a chec2 drawn on one ban2 is deposited in another ban2 and no record is made (cash is recorded in 9 places at once (ec <)) ban2 transfer schedule compares the dates chec2s are drawn to the dates chec2s are deposited •
standard ban2 confirmation should be sent to all ban2s that the client has done business with during the year, regardless of whether there is a year end balance to confirm. -otential misstatements $ecording fictitious sales (existence assertion) 7olding open the sales 3ournal to include next year’s sales (improper cutoff) &hipping unordered goods near year end which can be returned (bill and hold) ailure to record payments &ales ad3ustments may be used to conceal thefts of cash collections • • • • •
$educe ris2 by $% 22
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Audit (ocumentation udit documentation (wor2papers) belong to the %- (not the clients acctg records) and are meant to support the auditors opinion and record audit procedures performed and e"idence obtained udit documentation should: Indicate that the accounting records support/reconcile to the /& %ontain enough detail so an auditor with no prior 2nowledge can understand the whole audit &upport that the audit was conducted in accordance with +& • • •
$eport release date ! date on which the auditor grants the client permission to use the report (usually date report is deli"ered to the client) or pri"ate companies, auditing standards require audit documentation be completed A; days from report release date and held for @ years from that date or pri"ate companies, the -%#> requires audit documentation be completed ?@ days from report release date and held for B years from that date 0he specific quantity, type and content of audit documentation are based on the auditors 3udgement Permanent continuous- file ! audit documentation that has continuing interest from year to year C contracts, pension plans, leases, stoc2 options, bylaws Current file ! all audit documentation applicable to the year under the audit
udit documentation should include significant audit findings, actions ta2en, and conclusions reached, such as: &election and application of accounting principles -ossible material misstatements 1eed to re"ise the auditors pre"ious ris2 assessment &ignificant difficulty in applying necessary audit procedures 4odification to the auditors standard report • • • • •
Gou can pro"ide audit documentation to another party without the clients permission: If it’s subpoenaed in court 0o your defense team: lawyers, insurance company, expert witnesses I%- for an in"estigation or quality re"iew • • •
Audit Evidence udit e"idence ! all the information an auditor uses to arri"e at the opinion 0he auditor should ha"e access to all pertinent accounting data and corroborating e"idential matter (otherwise it’s a scope limit) 0ypes of audit e"idence *nderlying accounting records ! test through analytical procedures and substanti"e tests, such as retracing, recalculation and reconciliation %orroborating e"idence ! pro"ides additional support for the acctg data6 obser"ation, inquiry and inspection •
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5lectronic e"idence ! consider the time during which information exists or is a"ailable in determining the nature, extent and timing of audit procedures.
0he third standard of fieldwor2 ! '0he auditor must obtain sufficient appropriate e"idence by performing audit procedures to afford a reasonable basis for an opinion regarding the /& under audit 5"idential matter must persuade the auditor that the ending balance in the /& are fairly presented (persuasi"e rather than conclusi"e) %ost/benefit relationship may be a "alid reason for performing only certain procedures, cost alone or difficulty in obtaining e"idence is not a "alid basis for omitting a procedure 5"idential matter should be "alid and rele"ant 0he greater the ris2 of material misstatement the more e"idence will be required 0he higher the quality of audit e"idence the less audit e"idence needed 5"idence must relate to the financial statement assertion under consideration 0he e"aluation of e"idential matter must ta2e into consideration the achie"ement of audit ob3ecti"es &ubstanti"e procedures are performed to e"aluate mgmt’s assertions which help detect material misstatement &ubstanti"e procedures consist of: . 0est of details (applied to transactions balances and disclosures) 9. &ubstanti"e analytical procedures nalytical -rocedures %omparison of financial data ! re"iew current and prior year’s /& and the current years budget, industry norms, and nonfinancial information 4ost effecti"e and efficient for assertions in which potential misstatements are not apparent from detailed e"idence or is not a"ailable •
•
0he I/& has more predictable relationships than the >/& ccts with mgmt discretion are less predictableM nalytical procedures for planning phase and final re"iew phase are required. 7owe"er analytical procedures used as substanti"e tests are not required. ocumentation requirements, expectation, factors, results, additional audit procedures performed and results of those procedures In"estigate significant differences (if found): ma2e inquires of mgmt, in necessary expand audit procedures or alternati"e substanti"e procedures. ifferences do not necessarily indicate errors or fraud, but simply indicate the need for further in"estigation nalytical procedures are applied during the o"erall re"iew stage of an audit to e"aluate the o"erall /& presentation and assess the conclusions reached 0est of etails irectional testing refers to testing either forward or bac2ward If a test starts with items in the accounting records, the proper assertion is most li2ely existence 24
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If a test starts with source documents, it is most li2ely related to the completeness assertion &tandard auditing procedures ! IK5 %$$#0& ! ooting, crossfooting, recalculation ! "erify mathematical accuracy I ! Inquiry ! both internal and external K ! Kouching ! directional testing6 auditor examines support for existence and occurrence assertions 5 ! 5xamination/Inspection ! pro"ides e"idence about the existence assertion % ! %onfirmation ! 0ype of inquiry obtained from third party ! nalytical procedures ! e"aluate financial information through the study of data relationships $ ! $eperformance ! auditor reCperforms procedures or controls originally performed by the client $ ! $econciliation ! substantiates the existence and "aluation of accounts # ! #bser"ation ! auditor loo2s at a process or procedure performed by others 0 ! 0racing ! directional testing6 examines support for the completeness assertions & ! &ubsequent e"ents re"iew ! perform certain procedures after balance sheet date #ther procedures %utCoff testing 0est related account simultaneously $equesting a comprehensi"e mgmt representation letter $eading pertinent information • • • •
Evidential %rocedures for Selected Accounts In"entory 0he obser"ation of beginning and ending in"entory is required. 4ay use alternati"e procedures to 3ustify an opinion (acceptable when its impractical or impossible to obser"e in"entory. 0he client counts the in"entory and the auditor simply obser"es and test counts certain items %onsigned in"entory on hand is excluded from in"entory count $elated accounts ! in"entories, purchases, sales, sales returns and allowances, and %#+& 0he auditor should examine purchase in"oices and recei"ing report around yr end for cutCoff testing 0he auditor should examine sales in"oices and compare them to shipping documents around yr end for cutCoff etermine whether in"entory adhere to lower of cost or mar2et principles and whether in"entory is pledged or sub3ect to liens 5xamine "endor in"oices, direct labor rates and test the computation of o"erhead rates ccounts recei"able confirmations -ositi"e confirmations ! request response from the recipient (may be blan2) >est type of confirmation for: large accounts, expect errors and disputes, wea2 internal controls greater degree of assurance but may result in lower response rate 1onCresponses should be: followed up, the client may ha"e to inter"ene, perform alternati"e procedures +enerally pro"ide e"idence regarding existence and rights and obligations • • • •
1egati"e confirmations ! recipient is as2ed to respond only if the amount stated in incorrect 1ot as good as positi"e confirmation •
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*se when there is low ris2, small balances, belief that the receipt would respond if there was a discrepancy
ccounts payable confirmation ! not required re positi"e confirmations and generally left blan2 #b3ecti"e is to determine whether /- is understated &hould be sent when internal control is wea2 0ypically send to "endors with small or Lero balances would be selected for confirmation 7owe"er, unrecorded liabilities generally surface e"entually when unpaid "endors stop deli"ering goods • • • •
-ayroll and -ersonnel 0here should be segregation of duties as follows uthoriLation to employ and pay ! function of 7$ to hire new employees &uper"ision ! all pay base data (hours, timeCoff) should be appro"ed 0ime2eeping and costs accounting ! data on which pay is based, hours wor2ed or 3obs completed -ayroll chec2 preparation ! computes salary based on information recei"ed, later signed by the treasurer • • • •
%ontrol procedures ! -I 0I-& --5 cquisition ! a special requisition form is needed. cquisitions are ties to the capital budget and the board of directors should also ha"e to appro"e the acquisition. &ubsidiary ledgers ! detailed information on each asset is 2ept in the subsidiary ledger -hysical security Written policies ! on depreciation and capitaliLation isposition ! retirement of assets should be documented and sequentially numbered •
• • • •
udit procedures Kouch additions $e"iew retirements and recalculate any gains/losses $e"iew repair and maintenance accounts in order to locate items that should ha"e been capitaliLed >e alert for lien’s on assets (borrowed) C %ompanies cannot/do not insure fixed assests they do not ha"e C %ompanies do not pay real estate taxes on property they don’t own C 0our plant and inquire • • • •
Diabilities 1otes payable ! examine the note, comparing terms and amounts to board appro"al. Interest expense should be independently computed Dong term debt ! ensure that interest expense is properly reported, "aluation is fairly reported, all debt has been recorded. %ompare interest expense with the bond payable amount for reasonableness %ontingencies ! loo2 at guarantees, purchase commitments, leases, tax returns, clients legal counsel •
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#wners 5quity 0reasury stoc2 ! auditor should examine all shares of treasury stoc2 and reconcile the number of 0& shares. %ompare to authoriLation in the minutes of the board meeting &toc2 transactions ! "ouch to supporting documentation •
•
ll issues relating to stoc2, di"idends, and 0& must be authoriLed by the board of directors rticles of incorporation goes in the permanent audit file 26
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If the client uses a stoc2 transfer agent, use third party confirmations If the client doesn’t use a stoc2 transfer agent, chec2 the stoc2 certificate boo2 %onsider whether any appropriations of retained earnings are necessary (due to loan co"enants). 0he auditor focuses on e"aluating the presentation and disclosure of the /& (mgmt assertions H classification = understandability)
Audit Evidence) *iscellaneous Items $elated -arty 0ransactions %oncerned about "aluation and accuracy related party transaction is not considered to be an arms length transaction &hould be adequately disclosed • • •
etermining the existence of related party transactions 5"aluate company’s procedures and policies for related party transactions Inquire mgmt and predecessor auditor $e"iew entity’s filings with the &5% $e"iew board minutes %ompensating balance agreements Doan agreements *nusual, nonCrecurring transactions new year end • • • • • • •
ccounting 5stimates ssess mgmt’s written policies and practices of acctg estimates Kerify that all material estimates ha"e been de"eloped etermine that the accounting estimates are reasonable 5nsure that the accounting estimates are properly presented and disclosed in conformity with +0est for reasonableness re they using the same methods -ast trac2 record of estimates is good 8ustify any changes in approach • • • • • • • •
uditing air Kalues 5stimates and "aluation methods may be used when mar2et "alues are not a"ailable %hanges in fair "alue measurements may be treated in different ways under +- (1I or #%I) 5"aluate the sufficiency, competency, and consistency of e"idence obtained with respect to fair "alue measurements and disclosures. etermine whether mgmt’s significant assumptions pro"ide a reasonable basis for fair "alue measurement • • •
•
Ditigation 4gmt is the primary source of information regarding litigation. n external inquiry of the entity’s attorney is simply a means to corroborate information pro"ided by mgmt. $ $e"iew minutes, in"oices from lawyers, and I$& correspondence Its mgmt’s responsibility to identify and account for litigation, claims •
• •
Detter inquiry to clients attorneys should be signed by the client but sent to the lawyer by the auditor 27
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0he lawyers response to the letter should include a professional opinion on the expected outcome of any lawsuit and the li2ely outcome of any liability, including court costs If the lawyer refuses to respond scope limitation qualified or disclaimer opinion %lient refuses to permit inquiry disclaimer opinion
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Audit Sampling +statistic sampling Sampling ris* ! reach the wrong conclusion based on the sample
lthough statistical sampling aids the auditor in quantitati"e ways, it is not a substitute for professional 3udgement. -rofessional 3udgement is still needed/required to set parameters and e"aluate the results. 9 main types of sampling . Attribute sampling rate of occurrence- ! used for testing internal controls (yes/no questions) 9. 0ariable sampling probability'proportional to si1e PPS or estimation sampling or numerical $uantity- ! used in substanti"e testing of account balances (J "alues) Audit ris* ! ris2 of getting the opinion wrong due to uncertainty in applying audit procedures (sampling and other) &is* of assessing control ris* too lo" ! ris2 that the assessed le"el of control ris2 based on the sample is less than the true ris2 based on the actual operating effecti"eness of the control (i.e. sample results indicate a lower de"iation rate than actually exists in the population) &is* of assessing control ris* too #ig# ! ris2 that the assessed le"el of control ris2 based on the sample is greater than the true ris2 based on the actual operating effecti"eness of the control. sample results indicate a greater de"iation rate than actually exists in the population
0here are two sorts of mista2es an auditor can ma2e with sampling: . 0he auditor may fail to identify an existing problem (incorrect acceptance and assessing control ris2 too low) 9. 0he auditor may falsely identify a problem where none exist (incorrect re3ection and assessing control ris2 too high) 0he ris2 of incorrect acceptance and the ris2 of assessing control ris2 too low relate to the effecti"eness of an audit in (possibly not) detecting an existing material misstatement. uditors usually accept a ris2 of @N (or ;N). In"erse to the ris2 is the confidence le"el (also called reliability). 0he auditor is O@N confident that the sample is representati"e of the population. 0he ris2 of incorrect re3ection and the ris2 of assessing control ris2 too high relate to the efficiency of the audit (the auditor does more audit wor2 than is necessary) ttribute &ling -lanning considerations $elationship between the sample to the ob3ecti"e of the test of controls 0olerable de"iation rate ! maximum rate of de"iation from a prescribed procedure the auditor will tolerate without modifying planned reliance (or changing control ris2 assessment) on internal control. $ate set by the auditor uditors allowable ris2 of assessing control ris2 too low %haracteristics of the population • •
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e"iation rate ! auditors best estimate of the de"iation rate in the population from which the sample was selected. 0here is a direct relationship to sample siLe: the fewer the de"iations expected, the smaller the sample siLe would be needed. -opulation of ;;; and sample ;; items and B de"iations identified within the sample BN sample de"iation rate 5stimate B; de"iations in the population (BN sample de"iation rate) 29
AUD - Notes Chapter 1 http://www.cpa-cfa.org
If the estimated de"iation rate for the entire population is less than the tolerable rate for the population, the auditor should consider the ris2 that such a result might be obtained e"en though the true de"iation rate for the population exceeds the tolerable rate for the population. or example assume the tolerable rate for a population is @N and the sample consists of A; items: If no de"iations are found in the sample of A;, the auditor may conclude that there is an acceptably low sampling ris2 that the true de"iation rate in the population exceeds the tolerable rate of @N (this is because the sample de"iation rate is much less than the tolerable rate) If the sample includes two or more de"iations (9 in A; H <.< standards require: Issuers report (within the annual report) on mgmt’s assessment of the effecti"eness of the company’s internal control o"er financial reporting, and uditors attest to (audit) the accuracy of mgmt’s report •
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0he auditors report must disclose material wea2nesses in internal control, but is not required to disclose significant deficiencies that are not material wea2ness (different than the attestation standards) If an auditor conducts the audit (of a nonissuer) in accordance with both +& and -%#>, the auditor may indicate in the auditors report that the audit was conducted in accordance with both standards
-overnment Auditing uditors responsibilities #btaining reasonable assurance that the /& are free of material misstatements resulting from "iolations of laws and regulations that ha"e direct and material effect on the /& #btaining an understanding of the possible effects on /& of laws and regulations ssessing whether mgmt has identified laws and regulations that ha"e direct and material effect %ommunicating to mgmt and the audit committee that an audit in accordance with +- may not be sufficient if, during the audit, the auditor becomes aware that the entity is sub3ect to additional audit requirements that may not be encompassed in the terms of the engagement •
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ttestation engagements performed in conformity with +enerally ccepted +o"ernment uditing &tandards (++&) (the yellow boo2) incorporate the I%-’s standards for examinations, re"iews, and agreed upon procedures by reference and include expanded requirements udit requirements for federal financial assistance . 5xpanded internal control documentation and testing requirements 9. 5xpanded reporting to include formal written reports on the consideration of internal control and the assessment of control ris2 <. 5xpanded reporting to include whether the federal financial assistance has been administered in accordance with applicable laws and regulations (compliance requirements) ?. pplication of single audit standards to federal financial assistance @. uditors pro"ide a copy of their peer re"iew to go"ernment audit clients 32
AUD - Notes Chapter 1 http://www.cpa-cfa.org
4gmt is responsible for the entity’s compliance with laws and regulations 4gmt has identified and disclosed in writing to the auditor all the laws and regulations that ha"e a direct and material effect on its /& udit reports should be distributed to the appropriate officials of the entity requiring or arranging for the audit (including external funding sources) ++& requires a written report on the auditors understanding of internal control and the assessment of control ris2 in all audits. 0his is different from +&, which requires written communication only when significant deficiencies are noted &ingle audits: #4> %ircular C<< 0he single audit act (#4> %ircular C<<) requires entities that expend total federal assistance equal to or in excess of J@;;,;; in a fiscal year to ha"e an audit performed in accordance with the ct -rograms classified as ma3or are those that expend J<;;,;;; or more in federal financial assistance, but smaller programs may be deemed ma3or is they are classified as high ris2 4ateriality e"aluation in a single audit includes a separate e"aluation of materiality for each ma3or program selected Single audits C audits of an entire organiLation that include additional audit procedures on specific programs and include a report on the /& of the whole organiLation and audit reports on the specific programs program'specific audits C audits of specific programs and do not include reports on the /& of the organiLation ta2en as a whole •
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uditor communication requirements increase in go"ernment settings. uditors often ha"e the responsibility of reporting significant deficiencies to specific regulatory bodies or grantor agencies A'%3 c#art memori1e
Communication ith the Audit Committee Audit committee ! committee of the board of directors, composed of
