An independent audit aids in the communication of the economic data because the audit
Lends credibility to the financial statements
.
Which of the following best describes the reason why an independent auditor is often retained to report on financial statements?
Different interests may exist between the entity preparing the statements and the persons using the statements, and thus outside assurance is needed to enhance the credibility of the statements.
Which of the following best describes relationships among auditing, attest, and assurance services?
Auditing is a type of assurance service.
Which of the following statements relating to attest and assurance services is not correct?
Financial statement auditing is a form of attest service but it is not an assurance service.
(this is false)
For what primary purpose does the auditor obtain an understanding of the entity and its environment?
To plan the audit and determine the nature, timing, and extent of audit procedures to be performed.
Which of the following statements best describes the role of materiality in a financial statement audit?
The lower the level at which the auditor assesses materiality, the greater the amount of evidence the auditor must gather.
Which of the following is the most important reason for an auditor to gain an understanding of an audit client's system of internal control over financial reporting?
Understanding a client's system of internal control can help the auditor assess risk and identify areas where financial statement misstatements might be more likely.
Preliminary engagement activities include
-*Understanding the client and the client's industry
-Determining audit engagement team requirements
-Ensuring the independence of the audit team and audit firm*
Which of the following statements best describes what is meant by an unqualified audit opinion?
Issuance of a standard unqualified auditor's report indicates that in the auditor's opinion the client's financial statements are fairly presented in accordance with agreed-upon criteria, with no need for the inclusion of qualifying phrases.
The auditing standards used to guide the conduct of the audit are
Explicitly referred to in the scope paragraph of the auditor's standard report.
A client has used an inappropriate method of accounting for its pension liability on the balance sheet. The resulting misstatement is material, but the auditor does not consider it to be pervasive. The auditor is unable to convince the client to alter its
Qualified opinion due to departure from GAAP
Which of the following is not a part of the role of internal auditors?
Providing reports on the reliability of financial statements to investors and creditors (role of external auditors)
Operational auditing is oriented primarily toward
Further improvements to accomplish the goals of management
Which of the following would be considered an assurance service engagement?
-Expressing an opinion about the
reliability
of an entity's financial statements
Which of the following best places the events of the last decade in the proper sequence?
Increased consulting services to auditees, Enron and other scandals, Sarbanes-Oxley Act, prohibition of most consulting work for auditees, establishment of PCAOB
Which of the following statements best describes management's and the external auditor's respective levels of responsibility for a public company's financial statements?
Management has the primary responsibility to ensure that the company's financial statements are prepared in accordance with GAAP, and the auditor provides
reasonable assurance
that the statements are free of material misstatement.
Which of the following best describes the relationship between business objectives, strategies, processes, controls, and transactions?
To achieve its objectives, a business formulates strategies and implements processes, which are carried out through business transactions. The entity's information and internal control systems must be designed to ensure that the transactions are properly
The Public Company Accounting Oversight Board
Is a quasi-governmental organization that has legal authority to set auditing standards for audits of public companies.
Which of the following is correct regarding the types of audits over which the ASB and PCAOB, respectively, have standard-setting authority in the United States?
*ASB--nonpublic company audits
PCAOB--public company audits*
Which of the following best describes the general character of the three generally accepted auditing standards classified as standards of field work?
Criteria for audit planning and evidence gathering.
Which of the following statements best explains why public accounting, as a profession, promulgates ethical standards and establishes means for ensuring their observance?
Ethical standards are established so that users of accounting services know what to expect and accounting professionals know what behaviors are acceptable, and so that discipline can be applied when necessary.
All of the following non audit services are identified by the SEC as generally impairing an auditor's independence except
Some specific tax services
Under the SEC's rules regarding independence, which of the following must an entity disclose?
Fees for the external audit, audit-related fees, tax fees, and fees for other non audit services performed by the audit firm.
The AICPA Code of Professional Conduct contains both general ethical principles that are aspirational in character and a
Set of specific, mandatory rules describing minimum levels of conduct a CPA must maintain.
In which of the following situations would a CPA's independence be considered impaired according to the Code of Professional Conduct?
-The CPA has a
direct financial interest
in an audit entity but the interest is maintained in a blind trust
-The CPA owns a commercial building and leases it to an audit entity. The rental income is
material
to the CPA.
An audited entity company has not paid its 2013 audit fees. According to the AICPA Code of Professional Conduct, for the auditor to be considered independent with respect to the 2014 audit, the 2013 audit fees must be paid before the
2014 report is issued.
Which of the following legal situations would be considered to impair the auditor's independence?
Actual litigation by the auditor against the present management, alleging management fraud or deceit.
A violation of the profession's ethical standards is least likely to occur when a CPA
Purchases another CPA's accounting practice and bases the price on a percentage of the fees accruing from entities over a three-year period.
Before accepting an audit engagement, a successor auditor should make specific inquiries of the predecessor auditor regarding the predecessor's
Understanding as to the reasons for the change of auditors.
A written understanding between the auditor and the entity concerning the auditor's responsibility for the discovery of illegal acts is usually set forth in a(n)
Engagement letter
Miller Retailing, Inc., maintains a staff of three full-time internal auditors who report directly to the audit committee. In planning to use the internal auditors to help in performing the audit, the independent auditor most likely will
Place limited reliance on the work performed by the internal auditors
During the initial planning phase of an audit, a CPA most likely would
Discuss the
timing
of the audit procedures with the entity's management
When planning an audit, an auditor should
Determine
overall materiality
for audit purposes.
As generally conceived, the audit committee of a publicly held company should be made up of
Members of the board of directors who are not officers or employees.
Which of these statements concerning illegal acts by clients is correct?
An auditor's responsibility to detect illegal acts that have a direct and material effect on the financial statements is the same as that for errors and fraud.
The engagement partner and manager review the work of engagement team members to evaluate which of the following?
-*The work was performed and documented
-The objectives of the procedures were achieved
-The results of the work support the conclusions reached*
Tolerable misstatement is
Materiality used to establish a scope for the audit procedures for the individual account balance or disclosures
Which of the following is not a qualitative factor that may affect an auditor's establishment of materiality?
Firm policy sets materiality at 4 percent of pretax income
Financial statement assertions
The claims made by the management regarding the information presented in the financial statements.
Assertions are the main focus of the auditor's efforts, as they are what the auditors will be testing in regards to the truthfulness of the financial statem
At a general level, auditing, attest, and assurance encompass the same process:
The systematic evaluation of evidence to determine whether information has been recorded and presented in accordance with a predetermined set of criteria, together with the issuance of a report that indicates the degree of correspondence to GAAP criteria.
Auditing
A systematic process of objectively obtaining and evaluating evidence regarding assertions about
economic actions and events
to ascertain the degree of correspondence between those assertions and established criteria and communicating the results to inter
Attestation
Occur when a practitioner is engaged to issue a report on subject matter or an assertion about subject matter that is the responsibility of another party.
Not limited to economic events or actions
. Financial statement auditing is a specialized form of at
Assurance
Reporting not only on the reliability and credibility of information but also on the
relevance and timeliness
of that information. Can include almost any service provided by accounting professionals that involves
capturing information, improving its quali
Securities and Exchange Commission (SEC)
Federal government agency with power over both accounting and auditing of public companies, scare management and indirectly scare us. SOX mandated that the SEC impose strict independence rules, prohibiting auditors from providing many types of non audit s
Public Company Accounting Oversight Board (PCAOB)
Nonprofit corporation established by Congress to oversee the audits of public companies in order to protect interests of investors and further the public interest in the preparation of informative, accurate, and independent audit reports.
Quasi-government
American Institute of Certified Public Accountants (AICPA)
(Auditing Standards Board)
Private professional association that provides the promulgation of rules and standards that guide audit and related services provided to nonpublic companies, governmental entities, and other entities such as universities and charities.
Corporate governance
The
behavior and actions
of the board of directors to ensure proper stewardship of investor assets. (We do not want to work with a weak board). Consists of all the people, processes, and activities in place to help ensure proper stewardship over an entity
The Audit Committee of the BOD
-Oversight of
--financial reporting
--auditing
-External Audit
--hire and fire firm
--Set fee
-Internal Audit
--hire C-level Audit Exec
--Hire and fire head of IA (same as with EA)
--Review and approve IA scope and budget
-Complaints/whistleblowers
-Liais
About the Board of Directors:
-All independent
-All "financially literate" (straight from SOX)
-One "financial expert" (CPA)
-Must understand
--company/industry accounting challenges
--management's significant accounting choices
--significant Internal Controls over Financial Reporting
How would this situation differ for a private/nonpublic company?
-May have a board
-Not required to be audited; they are audited at their option or at requirement of investor.
External Auditors
Also referred to as "independent auditors", audit financial statement for publicly traded and private companies, partnerships, municipalities, individuals, and other types of entities.
Must be a CPA to sign an audit opinion on an entity's financial statem
Internal Auditors
Auditors who are employees of individual companies, partnerships, government agencies, and other entities. "Independent, objective assurance and consulting activity designed to add value and improve an organization's operations."
Helps an organization acc
Internal Control Audits
The Sarbanes-Oxley Act was the first to require public companies to engage an external auditor to provide an opinion on the effectiveness of internal control. Auditing standards to public companies
require
an
integrated audit
of internal control and finan
Compliance Audits
Determines the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity being audited. Ex: IRS
Operational Audits
Involves a systematic review of part or all of an organization's activities to evaluate whether resources are being used effectively and efficiently.
Purpose is to assess performance, identify areas for improvement, and develop recommendations
. Requires
Public Accounting Firms
The national and international firms structure themselves as Limited Liability Partnerships (LLPs). Under an LLP, partners are not
personally
responsible for liabilities arising from other partners' and most employees' negligent acts. However, the persona
Professional skepticism
An attitude required by
due professional care
, that includes a questioning mind and a critical assessment of audit evidence.
Five Business Processes
-Financing Process
-Purchasing Process
-Human Resource Management Process
-Inventory Management Process
-Revenue Process
Management engages in the five business processes to implement the organization's strategies and to achieve its objectives. Management
Financial Accounting Standards Board (FASB)
A privately funded body whose mission is to establish standards for financial accounting and reporting.
10 Generally Accepted Auditing Standards
The standards of the PCAOB", composed of three categories of standards: general standards (three), standards of field work (three), and standards of reporting (four).
Three General Standards
Deal with the auditor's
qualifications
and the
quality
of his or her work. (Characteristics of a Reliable House Inspector).
Three Standards of Field Work
Relate to the
actual conduct
of the audit. Provide the conceptual background for the audit process (and remind you of desirable characteristics of house inspection service).
Four Standards of Reporting
Require that the auditor consider each of the following issues before rendering an audit report: (1) whether the financial statements are presented in accordance with generally accepted accounting principles, (2) whether those principles are consistently
Principles Underlying an Audit Conducted in Accordance with Generally Accepted Auditing Standards
As a part of improving clarity and converging with international standards, the ASP replaced the 10 GAAS with a more comprehensive and coherent description of "the principles underlying an audit conducted in accordance with generally accepted auditing sta
Periodic Corporate Reports (Public): 10-K
(Pretty stuff of annual report cut out)
-Includes
--Summary info up front (company history, organization, nature of business, etc).
--Management's Discussion and Analysis (MD&A)
--Audited financial statements (what our report refers to)
-Filed within 60 d
Periodic Corporate Reports (Public):10-Q
-Update of changes during the quarter (since last periodic filing)
-Less front matter
-Includes quarterly financial statements
--not audited but
reviewed
(review is far less in scope than an audit)
-Filed within 40 days of QE (small & mediums get 45) comp
Two indicators to note
-.../A=amended (10-K/A; 10-Q/A; etc.) business world uses the term
restatement
(something is wrong and the auditor didn't call it out)
-NT...=will be filed late, 15 day extension (NT 10-K; NT 10-Q; etc).
Another signal to the market that the company did n
Informational Report
-8-K;
Material changes to company in-between periodic filings
(22 different categories of changes that have to be reported on 8-K)
-
Rapid report of unscheduled material events
--Examples: acquisition, bankruptcy, resignation of directors, or a change in
S-1: Registration (IPOs)
-Statement under Securities Act of '33.
-Establishes law for when company wants to go public (registering with SEC).
Required by Act of '33
The impact of SOX: Section 302
S 302:
Signature
of CEO and CFO on 10-K and 10-Q
-Reviewed the entire filing
-True and complete
-Fairly presents the financial condition and results of operations
-Responsibility for internal controls
-Alerted auditor (and AC) about internal control defic
The impact of SOX: Sections 303 and 304
S 303: illegal to coerce, manipulate, or mislead the auditor
S304: forfeit benefits from financial statements that are restated due to misconduct; "Clawback Provision" of SOX
(whatever you gain from the misstated financials, you have to pay back to the co
How are audit results given to investors?
Report of Independent Registered Public Accounting Firm
-If the auditor is not independent, it has no value
-It is written to BOD, not Executives
-We are limited in the assurance that we give, because we can't test everything
-Is there a better way to per
What are potential modifications to the opinion?
-
Qualified
--In our opinion, the financial statements referred to above present fairly,
except for
...
-
Adverse
--In our opinion, the financial statements referred to above
do not present fairly
-
Disclaimer
--We
do not express an opinion
on the financi
Applicable Standards when the Client is Private
Audits of privately held companies follow the standards of the AICPA (ASB)
:
-open to the public
-transparent process
-exposure draft
-comments taken
-revised and issued
As of today, 129 Statements on Auditing Standards
Applicable Standards when the Client is Public
Auditors of publicly held companies follow the standards of the PCAOB
:
-very closed process
-meetings not open
-use advisory board
-expose
-comments
-revise and issue
-seek SEC approval of the standard
-SEC expose
-SEC take comments
-SEC decide
why we on
Current PCAOB Agenda
-Auditor's Reporting Model
-Audit Transparency: Identification of the Engagement Partner and...
-Related Parties
-Codification Project
Standards for Auditor Professionalism
-The
AICPA
(and its predecessor, the American Association of Public Accountants), established auditing standards and a
Code of Professional Conduct
, mapping out the primary areas in which ethical conduct is expected of public accountants.
-The
SEC
has th
The AICPA Code of Professional Conduct consists of two sections:
1.Principles of Professional Conduct (setting forth ideal attitudes and behaviors)->
ideal, conceptual
2. Rules of Conduct (defining minimum standards)->
more specific, mandatory
The Principles of Professional Conduct provide the framework for the Rules o
Additional guidance for applying the Rules of Conduct is provided by:
1.
Interpretations
for the Rules of Conduct
2.
Rulings
by the Professional Ethics Committee (PEEC) Executive
Provide guidelines as to the scope and application of the Rules of Conduct.
-Not specifically enforceable, but an auditor who departs from them ha
Framework for the Code of Professional Conduct
The framework for the Code of Professional Conduct is provided by six fundamental principles:
-*Responsibilities
-The public interest
-Integrity
-Objectivity and Independence
-Due care
-Scope and nature of services*
Rules of Conduct
-Both the AICPA and PCAOB require their constituents to adhere to the
Rules of Conduct of the Code of Professional Conduct
. The PCAOB also requires auditors of public companies to adhere to the Rules of Conduct.
The Rules of Conduct cover much of the same ground as the Principles of Professional Conduct but are somewhat
more specific.
The rules are grouped and numbered into five categories:
-Independence, Integrity, and Objectivity (Section 100)
-General Standards and Accounting Principles (S 200)
-Responsibilities to Clients (Section 300)
-Responsibilities to Colleagues (Section 400)
-Other Responsibilities and Practices (Section 500)
The
Independence
AICPA Rule 101: A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by Council.
-AICPA's professional standards require a public accounting firm, including
The AICPA uses an engagement team approach to determine independence. Under this approach, a
covered member
includes:
-An individual on the attest engagement team
-An individual in a position to influence the attest engagement
-A partner or manager who provides non attest services to the attest entity beginning once he or she provides 10 hours of nonattest services to th
The AICPA prepared a Conceptual Framework for AICPA Independence Standards for use in evaluating other's considerations. Under this approach, a CPA is required to identify and asses the extent to which a threat to independence exists.
If such a threat does exist, the CPA considers whether the threat might
reasonably
be considered to compromise the member's professional judgment. If so, the CPA evaluates whether the threat can be effectively mitigated or eliminated. Depending on the eva
Financial Relationships
Interpretation 101-1 prohibits members from any financial relationship with an audited entity that may impair or give the appearance of impairing independence. This includes any
direct
or
material indirect
financial interest in the entity. (A direct inter
Financial interest
An ownership interest in an equity or debt security issued by an entity, including
rights and obligations to acquire such an interest.
Direct financial interest
A financial interest that is owned directly by an individual or entity, or is under the control of an individual or entity.
A financial interest that is beneficially owned through an intermediary (e.g., an estate or trust) is also considered a direct fina
Indirect financial interest
Arises when (a) an auditor or other covered member has a financial interest in an entity that is associated with an attest entity; (b) the financial interest is beneficially owners through an investment vehicle, estate, tryst, or other intermediary; and (
Financial Interest Part 2
If a CPA owns an insurance policy issued by an attest entity, independence is not impaired so long as the policy was purchased under the insurance company's
normal terms and procedures
and
does not offer an investment option
. However, some insurance poli
Financial Interest Part 3
Generally a loan to or from an audited entity is considered to impair the member's independence. Interpretation 101-5 permits the following loans from an audited entity that operates as a financial institution:
-Automobile loans and leases collateralized
Financial Interest Part 4
The rulings and interpretations of Rule 101 specify that if fees pertaining to services provided more than one year prior to the date of the audit report
remain unpaid
, the auditor's independence is impaired with respect to that entity. However, unpaid f
Business Relationships
Rule 101 essentially indicates that the independence of a CPA is impaired if the CPA performs a managerial or other significant role for an entity's organization
during the time period covered by an attest engagement.
(Ex: a CPA taking a position with a f
Business Relationships Part 2
-A firm's independence is considered to be impaired with respect to an entity if a partner or professional employee leaves the firm and is subsequently employed by or associated with that entity in a
key position
unless a number of conditions are met.
-If
Business Relationships Part 3
-A member of a CPA firm is allowed to serve as a director or trustee for an audited not-for-profit entity "
so long as his or her position is clearly honorary, and he or she cannot vote or otherwise participate in board or management functions
."
-A posit
Effect of Family Relationships
-A covered member's immediate family (spouse, spousal equivalent, or dependent) is subject to Rule 101 and its interpretations and rulings.
-A covered member's spouse employed by an audit entity would not impair independence if he or she were not employed
Effect of Actual or Threatened Litigation
-Threatened or actual litigation between the entity and the auditor can impair the auditor's independence. -Three categories of litigation: (1) litigation between the entity and the CPA, (2) litigation by security holders, and (3) other third-party litiga
Effect of Actual or Threatened Litigation Part 2
Guidelines for assessing independence when actual or threatened litigation exists between the audited entity and the CPA:
-The commencement of litigation by the present management alleging deficiencies in audit work for the entity would be considered to i
Provision of Nonattest Services
The AICPA Code of Professional Conduct restricts the types of nonaudit services that can be provided to attest services.
-The Code permits CPS to provide bookkeeping, systems implementation, internal audit outsourcing, and other services to
nonpublic
atte
Provision of Nonattest Services Part 2
-In performing non attest services for an attest entity, the CPA should ensure that the entity assumes all management responsibilities.
If the entity is unable or unwilling to assume the responsibilities of overseeing the non attest services, providing th
Provision of Nonattest Services Part 3
Management responsibilities that would be considered to impair a CPA's independence (if a CPA was performing them):
-Authorizing executives or consummating a transaction or otherwise exercising authority on behalf of an entity.
-Preparing source documents
Provision of Nonattest Services Part 4
-So long as the CPA stays within the general guidelines, the AICPA does not strictly prohibit the provision of most types of professional services to
nonpublic attest entities
. Performing these extended audit services would not be considered to impair in
SEC and PCAOB Independence Requirements for Audits of Public Companies
-While most of the SEC's independence rules are very similar to the AICPA's, the changes resulted in some important differences relating to
(1) the provision of other professional services, (2) handling of HR and compensation related issues, and (3) certa
Prohibited NonAudit Services for Public Company Audit Entities (According to SEC)
considered to impair independence
-Bookkeeping or other services related to the accounting records or financial statements of the audit entity.
-Financial information systems design
and
implementation
-Appraisal or valuation services, fairness opinions, or contribution in kind reports.
-A
Prohibited NonAudit Services for Public Company Audit Entities Part 2
-While PCAOB independence rules do not prohibit the provision of tax services to audit entities in general, they do identify circumstances in which the provisions of tax services impairs on auditor's independence including services that involve
aggressive
Human Resource and Compensation-Related Issues
-SEC rules in this area are primarily concerned with the potential for audit partners to become "too close" to an engagement or audited entity over time and with potential threats to an auditor's objectivity resulting from employment and compensation arra
Human Resource and Compensation-Related Issues Part 2
These rules can be summarized in three areas:
-The lead and engagement quality review partners on the engagement team for a public company audit are prohibited from providing audit services to the company for more than five consecutive years. A five-year
Required Communication
-SEC rules also differ from those of the AICPA in requiring
additional communication between auditors and their entities' audit committees
, and in requiring public company audit entities to
reveal information regarding the fees paid to their auditors for
Required Communication Part 2
-The audit committee must be responsible for the appointment, compensation, and oversight of the external auditor's work. This requirement establishes the audit committee as the entity to which the auditor reports, rather than management itself.
-Proxy st
Integrity and Objectivity
In the performance of any professional service, a member shall maintain objectivity and integrity, shall be free of conflicts of interest, and shall not knowingly misrepresent facts or subordinate his or her judgment to others (Rule 102).
-Interpretation
Integrity and Objectivity Part 2
-102-4 indicates that if a CPA working in industry has a disagreement or dispute with his or her supervisor relating to the preparation of financial statements or the recording of transactions, the member must take steps to ensure that the situation does
Requirements for Independence
-Independent in
Fact
=actions
--"Am I actually independent?" (very hard to detect; mental state CPAs should have; action actually from objective standpoint).
-Independent in
Appearance
(much easier to detect)
--Auditor must avoid circumstances that would
Client Acceptance and Continuance: Prospective Client Acceptance
-The successor auditor should request permission of the prospective client before contacting the predecessor auditor
-The successor auditor should make the following inquiries of the predecessor auditor:
--Information that might bear on integrity of manag
Client Acceptance and Continuance: Preliminary Engagement Activities
-There are generally three preliminary engagement activities:
(1) determining the audit engagement team requirements, (2) ensuring that the audit team and audit firm are in compliance with ethical and independence requirements, and (3) establishing an und
Client Acceptance and Continuance: Preliminary Engagement Activities Part 2
-The firm should document compliance with the
Code of Professional Conduct
by having all personnel complete an annual independence questionnaire or report.
-If an accounts receivable from an entity takes on the characteristics of a loan, the auditor's ind
Client Acceptance and Continuance: Establish an Understanding with the Entity
-The terms of the engagement, which are documented in the engagement letter, should include the objectives of the engagement, management's responsibilities, the auditor's responsibilities, and the limitations of the engagement.
-In establishing an underst
Client Acceptance and Continuance: Engagement Letter
-Formalizes the arrangements reached between the auditor and the entity. The audit is conducted in accordance with standards of the Public Company Accounting Oversight Board.
-May also include:
--Arrangements involving use of specialists or IAs
--Any limi
Client Acceptance and Continuance: Using the Work of the Internal Audit Function
The auditor may use the work of the IAF as evidence and request IAF assistance in conducting the audit.
-If the auditor determines that the work of the IAF can be used for purposes of the audit, the auditor must evaluate:
--The extent to which the IAF's o
Client Acceptance and Continuance: The Role of the Audit Committee (A subcommittee of the board of directors that is responsible for the financial reporting and disclosure procesS)
-For public companies,
the auditor is required to establish an understanding of the terms of the audit engagement with the audit committee and record the understanding in an engagement letter
.
-Under Section 301 of SOX, the audit committee of a public co
Planning the Audit: Audit Plan and Strategy
-In establishing the audit strategy, the auditor should determine the scope of the engagement, ascertain the reporting objectives to plan the timing of the audit, and consider the factors that will determine the focus of the audit team's efforts.
-Once th
Planning the Audit: Audit Plan and Strategy Part 2
Additional steps that should be performed include:
-Assess business risks
-Establish materiality
-Consider multi locations
-Assess the need for specialists
-Consider violations of law and regulations
-Identify related parties
-Consider additional value-ad
Planning the Audit: Assess Business Risk
Audit risk
is the risk that the auditor expresses an inappropriate audit report when the financial statements are materially misstated.
-Audit risk can be reduced by obtaining an understanding of an entity and its environment.
-Based on this understanding
Planning the Audit: Establish Materiality
Auditors consider materiality from a reasonable user perspective and communicate to users that "the financial statements present fairly in all material respects."
-During the planning of an audit, the auditor establishes a level of overall materiality for
Planning the Audit: Establish Materiality Part 2
-The auditor then assesses the risks of material misstatement to the consolidated financial statements associated with the location or business unit and correlates the amount of audit attention devoted to the location or business unit with the level of ri
Planning the Audit: Identify Related Parties
-Auditors should attempt to identify all related parties during the planning phase of the audit because the transaction may not be at arm's length
-The auditor needs to inquire of management about the names of related parties, the nature of the relationsh
Planning the Audit: Identify Related Parties Part 2
-The auditor compiles his or her knowledge about the entity's business objectives, strategies, and related business or audit risks. The auditor records how the entity is managing its risks (i.e., through internal control processes) and then documents the
Materiality
-The auditor designs the audit to provide reasonable assurance of detecting misstatements that are of
sufficient magnitude
to affect the judgment of reasonable financial statement users.
-Materiality is assessed in terms of the potential effect of a misst
Steps in Applying Materiality
Step One: Determine Overall Materiality
Overall materiality
is the maximum amount by which the auditor believes the financial statements could be misstated and still
not
affect the decisions of users.
-For public companies, firms typically use
2-5% of net income before taxes
-A common rule of t
Steps in Applying Materiality
Step Two: Determine Tolerable Misstatement
The purpose of setting tolerable misstatement is to establish a scope for the audit procedures for the individual account balance or disclosures.
-In practice, auditors commonly set tolerable misstatement for each account at between
50 and 75%
of overall
Steps in Applying Materiality
Step Two: Determine Tolerable Misstatement Part 2
-Combined tolerable misstatement is often capped to a multiple of overall materiality.
-Overall financial materiality serves as a "safety net". If the individual unadjusted misstatements are less than tolerable misstatement, but aggregate to an amount gre
Steps in Applying Materiality
Step Three: Evaluate Audit Findings
The auditor aggregates misstatements from each account or disclosure.
-In evaluating misstatements relating to accounting estimates, the auditor should be very careful in considering the risk of material misstatement in
accounts that are subject to estima
Steps in Applying Materiality
Step Three: Evaluate Audit Findings Part 2
-If the auditor's judgment about materiality at the planning stage (Step 1) was based on the same information available at the evaluation stage (Step 3), materiality for both purposes would be the same. However, the auditor may identify factors or items d
Common Quantitative Benchmarks and Relevant Percentages Used for Establishing Overall Materiality
-Income (Loss) before income taxes
3-10% (ROT 5%)
-Total Assets
.5-1%
-Total Revenues and Total Exp
.5-1%
-Net Assets
3-5%
-Total Equity
1-5%
-Current Assets or Current Liabs
2-5%
Also, consider the nature (qualitative) of misstatements, not just the amou
How is Acceptance/Retention Determined?
-Evaluate the riskiness of the client
-Talk to predecessor auditor (Our auditing standards require we initiate this conversation)
-Consider independence requirements
What are the nonaudit services that an auditor can include in his proposal for a public company that do not violate SEC rules?
The firm would be prohibited from helping the client
design or implement
a software system and from providing internal audit outsourcing. Provision of tax planning advice is allowed by SEC independence rules. Assisting the client to develop projections an
How would your answer change if the client were not publicly held?
Most of the nonaudit services would not be prohibited if the client were not publicly held, although there are restrictions to be observed. See the discussion relating to the AICPA's restrictions regarding financial information systems design and implemen
Which of the services may a CPA perform for a nonpublic company audit?
-Counsel on potential expansion plans
-Search for and interview new personnel
-Train personnel
Which of the services may a CPA not perform for a nonpublic company audit?
-Hire new personnel
-Supervise the operation of the system
-Monitor client-prepared source documents and make changes in basic IT-generated data without the concurrence of the client
Before undertaking this engagement, Perez should inform the entity of all significant matters related to the engagement. What are these significant matters that should be included in the engagement letter?
The significant matters related to an engagement generally include (a) the engagement's objectives, (b) the scope, (c) the approach, (d) the role of all personnel, (e) the manner in which results are to be communicated, (f) the timetable, and (g) the fee.
Janay Butler, a senior auditor, is aware that under SEC rules her accounting firm should not conduct appraisal or valuation services for a public company audit entity. However, her manager has requested that she appraise some specific large inventory time
As long as Janay is not providing the appraisal service for the client, but
only as part of the audit to verify the valuation assertion
, no violation has been committed. If the appraisal service were performed on behalf of the client, and not strictly fo
What additional procedures should Tish & Field perform in evaluating Rebel as a potential client?
-Obtain and review available financial information (annual reports, interim financials, income tax returns)
-Inquire of third parties about any information concerning the integrity of the prospective client and its management (bankers, attorneys, credit a
What matters would generally be included in the engagement letter?
-The objective of the audit
-Estimated completion date
-Management's responsibility for the financials
-The scope of the audit
-Other communication of the results of the engagement
-The fact that because of the test nature and other inherent limitations o
The preliminary engagement and planning activities that Parker needs to complete are:
-Reading the current year's interim financial statements
-Discussing the scope of the examination with management of the client
-Establish the timing of the audit work
-Arranging with the client for adequate working space
-Coordinating the assistance of c
Audit Opinion Letter (Addresses its Board and Stockholders): Intro
-Who, what, when
-States service, dates, F/S used
-Responsibility of management (F/S)
-Auditor's opinion is to express opinion on F/S and schedule based on audit
Audit Opinion Letter: Scope (How)
-Conducted audit in accordance with standards of PCAOB
-Explains standards: obtain reasonable assurance, free of material misstatement, test basis, assessing accounting principles used/significant estimates, evaluating overall F/S presentation,
believe au
Audit Opinion Letter: Opinion (Material Respects)
Type of opinion-hopefully UNQUALIFIED but could be->
-Qualified: present fairly except for
-Adverse: don't present fairly
-Disclaimer: no opinion
In conformity with U.S. GAAP
Also give opinion on internal controls for public companies
Firm signature and d
Engagement Letter: Services and Related Report
-Audit financials, internal controls, review 10Qs
-"If for any reasons
caused by you
or relating to the affairs of the company, we are unable to complete the audit, we may decline to issue a report as a result of this engagement.
Engagement Letter: Our responsibilities and limitations
-1st paragraph: auditor's responsibility, F/S, audit report
-2nd paragraph: auditor's responsibility, internal controls
-3rd paragraph: limitations, re: fraud
Engagement Letter: Management's Responsibilites
P1: F/S, bookkeeping, adjusting JEs, remaining adjustments, unbooked material
P2: ICs
P3: Cooperation
Other documents: using our name
Timing and fees: last section
The Items that should be included in a typical engagement letter for the first year audit
-Arrangements involving the use of specialists or internal auditors
-Any limitation of the liability of the auditor or clients, such as indemnification to the auditor for liability arising from knowing misrepresentations to the auditors by management or a
Audit Committee (Problem)
Subcommittee of the BOD that is responsible for the financial reporting and disclosure process. Audit committees are required for public companies subject to SOX and may be established by private companies. The audit committee should be composed of indepe
Which of the following statements best describes the primary purpose of Statements on Auditing Standards (SASs)?
They are generally accepted auditing standards.
According to AU-C 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with Generally Accepted Auditing Standards, presumptively mandatory requirements in the auditing standards are indicated by which word?
Should.
Audit committees have been identified as a major factor in promoting independence in both internal and external auditors. Which of the following is the most important limitation on the effectiveness of audit committees?
Audit committees are composed of independent directors. However, these directors may have close personal and professional friendships with management.
The auditor should not initiate discussion with those charged with governance concerning
Details of the procedures that the auditor intends to apply.
Through legal precedent, generally accepted auditing standards established by the AICPA apply
To all CPAs.
Which of the following statements best explains why the CPA profession has found it essential to establish ethical standards and means for ensuring their observance?
A distinguishing mark of a profession is its acceptance of responsibility to the public.
Which AICPA Conduct Rule applies only to members in the practice of public accounting?
Independence
When management refuses to disclose material noncompliance with laws and regulations identified by the independent auditor, the independent auditor may be charged with violating the AICPA Code of Professional Conduct for
Disclaiming an opinion (The auditor should disclose the problem in a report that includes either a qualified or adverse opinion).
Which of the following most completely describes how independence has been defined by the CPA profession?
Possessing the ability to act with integrity and objectivity.
The Conceptual Framework for AICPA Independence Standards
Adopts a risk-based approach to analysis of independence matters.
A CPA who has a direct financial interest in a non client having a material investment in the CPA's audit client
Lacks independence. (If the investment by the non client in the client is material, any direct or material indirect financial interest a covered member has in the non client will impair independence.)
A CPA purchased stock in an audit client corporation and placed it in a revocable educational trust for the CPA's dependent minor child. The trust securities were not material to the CPA but were material to the child's personal net worth. Is the independ
Yes, because the stock is considered a direct financial interest and, consequently, materiality is not a factor. (Because the covered member is a grantor of a revocable trust, the trust and its underlying investments are
direct financial interest
.)
Jordan is the executive partner of Cain & Jordan, CPAs. One of its clients is a large nonprofit charitable organization. The organization has asked Jordan to be on its BOD, which consists of a large number of the community's leaders. For Jordan to be cons
Board Participation Purely Honorary (Audit Participation by Jordan is Permitted).
Under Conduct Rule 101, Independence, which of the following must be independent in the performance of an audit?
All individuals on the attest engagement team, except those performing routine clerical functions.
In which of the following circumstances will a CPA who audits XM Corporation lack independence?
The CPA and XM's president each owns 25% of FOB Corporation, a closely held corporation. (Independence is impaired with regard to a client if, during the period of professional engagement, "a covered member had a joint closely held investment that was mat
According to the profession's ethical standards, an auditor is considered independent in which of the following instances?
The auditor's checking account, which is fully insured by a federal insurance agency, is held at a client federal institution (If an individual is a covered member, independence is not considered to be impaired provided that (1) the checkings (or savings,
A CPA audits the financial statements of a local bank. According to the AICPA Code of Professional Conduct, the appearance of independence ordinarily is not impaired if the CPA
USes the bank's time-sharing computer service to solve client-related problems (considered normal incident of an audit).
A CPA who performs primary actuarial services for a non issuer client normally is precluded from expressing an opinion on the financial statements of the client if the
CPA prepared an actuarial report using assumptions
determined by the CPA and not approved by the client
(Member should not assume management responsibilities for the attest client).
Under the ethical standards of the profession, which of the following investments in a client is not considered to be a direct financial interest?
An investment held through a 5% interest in a client that is not a direct financial interest.
Within the meaning of the Securities Act of 1933 and the Securities Exchange Act of 1934, an accountant deemed to be independent with regard to a specific entity must
-Confirm in writing its independence from the audit client
-Discuss its independence with the audit committee.
A violation of the profession's ethical standards most likely occurs when a CPA in public practice
Serves on a municipal board of income tax appeals, discloses that status to concerned parties and participates as a board member in a tax appeal involving a client but does not receive the client's consent for such action (
The failure to secure the clien
According to SEC independence regulations
Preapproval of accountants' services may be in accord with detailed policies and procedures rather than explicit (
Approval must be either explicit or in accordance with detailed policies and procedures
).
According to the PCAOB, an accounting firm's independence is least likely to be impaired if the firm
Has an audit client that employs a former firm professional.
According to the PCAOB, an accounting firm is most likely to be independent of its audit client if
The firm recommended an aggressive tax position to the client that is more likely than not to be legally allowed.
An auditor should agree with management upon the terms of an engagement. This agreement generally includes
The auditor's responsibility for ensuring that those charged with governance are aware of any significant deficiencies or material weaknesses in internal control that come to the auditor's attention.
An auditor's engagement letter most likely will include
Management's acknowledgment of its responsibility for maintaining effective internal control.
Which of the following statements would least likely appear in an auditor's engagement letter?
After performing our preliminary analytical procedures, we will discuss with you the other procedures we consider necessary to complete the engagement.
In assessing whether to accept a client for an audit engagement, a CPA should consider the
client's business risk and the CPA's business risk
Which of the following conditions most likely would pose the greatest risk in accepting a new audit engagement?
There will be a client-imposed scope limitation.
Which of the following circumstances would permit an independent auditor to accept an engagement after the close of the fiscal year?
-Remedy of audit limitations resulting from accepting the engagement after the close of the end of the year, such as those relating to the existence of physical inventory.
Early appointment of the auditor enables preliminary work to be performed by the auditor that benefits the client because it permits the audit to be performed in
A more
efficient
manner.
With respect to the auditor's planning of a year-end audit, which of the following statements is always true?
It is an acceptable practice to carry out part of the audit at interim dates.
In developing an audit plan, an auditor should
Perform risk assessment procedures.
Which of the following is an auditor least likely to perform in planning a financial statement audit?
Selecting a sample of vendors' invoices for comparison with receiving reports (test of details-->a substantive procedure).
Which of the following ultimately determines the specific audit procedures necessary to provide an independent auditor with a reasonable basis for the expression of an opinion?
The auditor's judgment.
One of the primary roles of an engagement work program is to
Serve as a tool for planning and conducting engagement work.