Exam 3 Review

Will begin with all course outlines.

There's two types of fraud relevant to the auditor's consideration:
-Fraudulent financial reporting
-Misappropriation of assets
For each, the risk factors are classified based on three conditions generally present when fraud occurs (*fraud triangle*):
-Incentives/Pressures
-Opportunities
-Attitudes/Rationalization

*Auditors moved away from primarily looking for fraud to verifying the financial statements are presented fairly. However, if fraud is suspected or caught obviously go and follow through with that.*

*You'll never get fraud under control if management doesn't agree to do things right, people at the top set the tone.*

-Fraud risk governance: org establishes and communicates a fraud risk management program
-Fraud risk assessment: org performs assessment to identify specific risks and schemes, likelihoods and significance, existing control activities, and implement actions to mitigate residual risks
-Fraud control activity: org selects, develops, and deploys preventative and detective control activities
-Fraud investigration and corrective action: org establishes a line to obtain potential fraud info and deploys a coordinated approach to investigation and corrective action
-Fraud risk management monitoring activities: org performs ongoing evaluations to make sure risk management is present and functioning and communicates deficiencies to parties that take corrective action

Most fraud perpetrators have worked for the company for over ten years. Most people do so because of weak internal controls. Also, the pressure to do "whatever it takes" to meet goals.

-Auditor must bring attention of appropriate management levels, even for minor embezzlements
-When fraud is suspected, the auditor must obtain additional evidence to determine whether material fraud has occured.
-Often, inquiry is required.
-Consideration of implications for other aspects of the audit is also required, for example petty cash theft may be insignificant but if it involved higher-management then a more pervasive problem is present with management integrity.

Report directly to audit committee:
-Fraud causing material misstatement of financial statements
-Any fraud involving senior management

*For governmental entities and not-for-profit organizations, requirements for reporting fraud, whether or not discovered through the audit process, may be subject to specific provisions of the audit mandate or
related law or regulation.*

AU 240.A.75

How can you defeat Benford's Law through embezzlement?

*Write off any account they perceive as uncollectible (no matter if current or noncurrent) before incrementing the allowance for bad debts.*

Intentional misstatement or omission of amounts or disclosures with the intent to deceive users of the financial statements.

Involves theft of an entity's assets.

i. Audit team brainstorming sessions, inquiries of management and audit committees. Auditing standards specifically require auditors to identify revenue recognition as a fraud risk in most audits.
ii. These are the most effective way to prevent and deter fraud.
iii. Test fraud controls that exist, further audit procedures if no fraud deterrent programs or controls are in place for risks. Overall responses, those at the assertion level, and those related to management override.

i.
ii. acquire additional evidence as needed, thoroughly probe the issues, and consult with other team members. do not assume the misstatement is an isolated incident. do not immediately withdraw. must document.

When the auditor receives inconsistent responses from management and others within the organization, the auditor should obtain additional audit evidence to resolve the inconsistency.

Management is responsible for identifying and measureing fraud risks, as well as taking steps to mitigate identified risks.

Documentation is required even if auditors determine that there is not a significant risk of material improper revenue recognition.

Typical fraud warning signs or red flags:
-Ineffective control environment
-Bonuses if unrealistic profit targets are met
-Need to meet expectations of third patries to obtain financing
-Ineffective oversight by those charged with governance
-Ineffective internal audit function
-No existence or enforcement of written code of conduct

Two of the most useful warning signals that can indicate that revenue fraud is occurring are analytical procedures and documentary discrepencies.

-Extensive use of "generally, usually, often, normally"
-Frequent rephrasing of the question
-Filler terms, "um, well, to tell you the truth"
-Forgetfulness and acknowledgements of nervousness
-Tolerant attitudes, such as "it depends" and overqualified responses such as "to the best of my knowledge"
-Reluctant to end an interview

10% won't steal no matter what, 10% will steal no matter what, and internal controls are designed for the remaining 80% that steal circumstantially.

PCAOB standards require auditors to perform "roll-forward" procedures to update the results of interim testing to year end.

Existence, accuracy, and cutoff objectives.

Confirmation of accounts receivable selected from the trial balance is the most common test of details of balances for the accuracy of accounts receivable.

When an auditor tests to determine if all existing accounts receivable are included in the aged trial balance, auditors rarely send accounts receivable confirmations to customers with zero balances.

When determining the timing of the accounts receivable confirmations, if accounts receivable are confirmed before year-end, the auditor typically prepares a roll-forward schedule.

When making the sampling decisions for accounts receivable confirmations, it is important to sample some items for every material segment of the population.

The auditor should perform procedures to verify the addresses used for the accounts receivable confirmations.

Each client misstatement in accounts receivable must be analyzed to determine whether it was consistent with the original assessed level of control risk.

• Positive confirmations are communications addressed to a debtor requesting the recipient to confirm whether the balance as stated on the confirmation is correct or incorrect.
• A blank confirmation is a type of positive confirmation that does not state the amount on the confirmation, but requests the recipient to fill in the balance or furnish other information.
• An invoice confirmation is a type of positive confirmation in which an individual invoice is confirmed rather than a customer's entire accounts receivable balance.
• Negative confirmations are addressed to debtor, but request a response only when the debtor disagrees with the stated amount.

Requires proof of accuracy by affirming that the original information was correct or by providing the correct information if incorrect

-Types of confirmation requests
-Conditions for positive requests (negative for AR rarely used)
-Evaluating identified misstatements
-Blank form confirmation request
-Alternative procedures for non responding positives

-requests the recipient to fill in the amount of the balance.
-Blank confirmations are not considered less reliable than standard positive confirmations.
-example: a letter, addressed to the debtor, requesting the recipient to fill in the amount of the accounts receivable balance

Should be performed:
-when customers do not return positive confirmation requests
-when confirmations are deemed to be ineffective as an audit procedure
-when confirmations are too costly to use

Examples of alternative procedures are:
-examine subsequent cash receipts to determine if the receivable has been paid.
-examine shipping documents to verify that the merchandise was shipped.
-examine sales invoice to verify the actual issuance of a sales invoice and the actual date of the billing.
-correspondence with the client is used to discover disputed and questionable receivables not uncovered by other means.

-The accounts receivable balance-related audit objective net realizable value is not affected by assessed control risk for sales or cash receipts.
- The net realizable value of accounts receivable is equal to gross accounts receivable less allowance for uncollectible accounts.

-Audit data analytics can be used to test accuracy of invoices outstanding at the end of the year by matching these invoices to subsequent cash receipts after year-end.
-to determine whether the accounts were collected. Auditors perform tests of the debits and credits to individual customers' balances by examining supporting documentation for shipments and cash receipts
-Examine subsequent cash receipts and the credit file on all accounts over 90 days and evaluate whether the receivables are collectible.

When testing the detail tie-in objective for accounts receivable, the total column and the columns depicting the aging on the aged trial balance must be test footed, and the total on the trial balance is compared with the general ledger. In addition, a sample of individual balances on the aged trial balance should be traced to supporting documents, such as duplicate sales invoices, to verify the customer's name, balance, and proper aging

Trace accounts from the aged trial balance to the accounts receivable master file to test for correctness of aging and the balance.

-The auditor evaluates management objectives and business processes to identify significant client risks that could affect the accounts receivable balance.
-When analytical procedures in the sales and collection cycle uncover unusual fluctuations, the auditor should make additional inquiries of management.
-To determine if the client has rights to the accounts receivable on the trial balance, the auditor should inquire of management if any receivables are pledged or factored.

-It is common for audit clients to misstate cutoff either by error or through fraud.
-Audit procedures designed to uncover credit sales made after the client's fiscal year-end that relate to the current year being audited provide evidence for cutoff objective.
- If the client's internal control for recording sales returns and allowances is evaluated as ineffective, a larger sample may be needed to verify cutoff
-Cutoff misstatement can occur for sales and sales returns and allowances
-The most important aspect of evaluating the client's method of obtaining a reliable cutoff is to evaluate the client's control procedures around cutoff
-Cutoff is least important for cash collections because it affects items on the balance sheet but not earnings (net income)
-Unrecorded sales for the year would be detected by sales cutoff
-If the client's policy is to record sales when title to the merchandise passes to the buyer, then the books and records would contain errors if the December 31 entries were for sales recorded before the merchandise was shipped
- A procedure to test for a cash receipts cutoff error is tracing recorded cash receipts to subsequent period bank deposits on the bank statement

1. Decide on the appropriate criteria for cutoff.
2. Evaluate whether the client has established adequate procedures to ensure a reasonable cutoff.
3. Test whether the cutoff was correct

- Cutoff misstatements occur when subsequent period
transactions are recorded in the current period AND current period transactions are recorded in the subsequent period
-Assuming the client's internal controls are effective, the auditor can verify proper cutoff of sales transactions by obtaining the shipping document number for the last shipment made at the end of the period and comparing this number with current and subsequent period recorded sales.
-Testing for balance-related audit objective: Select the last 20 sales transaction from the current year's sales journal and the first 20 from the subsequent year's and trace each to the related shipping documents.

- If sales returns and allowances and write-off of uncollectible accounts receivable are significant, the assessed control risk must be considered for these two classes of transactions.

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-Internal controls over payroll are effective for almost all companies, even small ones
-The overall audit objective in the audit of the payroll and the personnel cycle is to evaluate whether the account balances affected by the cycle are fairly stated according to the applicable accounting standards.
-In the payroll cycle, transactions are far more significant than related balance sheet accounts.

-Two circumstances which auditors would extend their procedures considerably in the audit of payroll:
(1) when payroll significantly affects the valuation of inventory
(2) when the auditor is concerned about the possibility of material fraudulent payroll transactions, such as nonexistent employees or fraudulent hours.
-Describe auditing procedures which an auditor can perform which could test for the possibility of nonexistent employees being paid by an audit client:
• Compare the names on cancelled payroll checks or the account into which payroll has been deposited with time records and other records for authorized signatures and reasonableness of the endorsements.
• Audit software can be used to compare all bank accounts numbers into which payroll is being deposited to search for duplicates.
• Examine payroll checks that are recorded as voided to make sure these checks have not been fraudulently used.
• If fraud is suspected, the auditor may access online banking records to review endorsements on cancelled checks of suspected disbursements.
• Trace selected payroll transactions recorded in the payroll journal to the human resources department to determine whether employees were actually employed during the payroll period.
• If payroll checks are being used, compare the endorsement on the cancelled payroll check with the authorized signature on the employee's withholding authorization forms in human resources.
• For a sample of terminated employees, obtain their files from human resources and determine if their termination pay was consistent with company policies.
• Use audit software to compare termination dates to payroll disbursement dates in the payroll journal.
• Request and perform a surprise payroll payoff
-test of details of balances procedures is ordinarily emphasized the least when auditing payroll
-calculation for payroll tax expense is costly and is not necessary unless analytical procedures indicate a problem that cannot be resolved through other procedures.

-management falsification of expense reports can be an indicator of disregard for internal controls and the potential for fraud in other areas.
-tests of controls is usually emphasized due to a lack of independent third-party evidence related to payroll transactions
-to test the completeness transaction-related audit objective in the payroll and personnel cycle, account for a sequence of payroll checks would be a reasonable test of control
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-Year end substantive testing
-Audit of year end payroll accrual
-Analytical procedures

Tony had convinced Dave that as controller, he would do the bank reconcoliations and also receive the payroll and disbursed it to himself. He was using a third party payroll comapny to issue large payroll advancements to himself, then larger negative advancements which cancelled out the large balances so that on the final balance it didn't show he was embezzling. Eventually, when he left the company Bill was to take over. However, Tony wasn't relinquishing control over the payroll reports so Bill looked into it himself. He noticed a few pages of the report were missing, and a coworker checked his office and foun dnothing. They looked into the paper shredder and pieced together the top documents, revealing Tony had advanced checks of 50,000 every month. They took this to the business owner, Dave, who requested more historical documents from the payroll company and launched criminal investigations.

Test of details of balances audit program.

*11. Perform alternative procedures for all confirmations not returned on the first or second request.
12. Discuss with the credit manager the likelihood of collecting older accounts. Examine subsequent cash receipts and the credit file on all larger accounts over 90 days and evaluate whether the receivables are collected.
13. Evaluate whether the allowance is adequate after performing other audit procedures for collectibility of receivables.*

-The test of transactions which requires one to "reconcile recorded cash disbursements with the cash disbursements on the bank statement" satisfies the objective of completeness
-You are performing an audit of Hawk Company. In evaluating the accounts payable balance you are concerned with the completeness assertion. Send confirmations to vendors with large, active, zero balance accounts and a representative sample of all others.
-Trace from a file of receiving reports to the acquisitions journal.
-Trace from a file of vendors' invoices to the acquisition journal

-The extent of a search for unrecorded liabilities largely depends on materiality and control risk.
-In searching for unrecorded liabilities, the purpose of the audit procedure to "examine underlying documentation for subsequent cash disbursements" is to uncover payments made in a subsequent accounting period for liabilities that existed at the balance sheet date.
• Examine underlying documentation for bills not paid several weeks after the year-end.
• Trace receiving reports issued before year-end to related vendors' invoices.
• Trace vendors' statements that show a balance due to the accounts payable trial balance.
• Send confirmations to vendors with which the client does business, including zero balance confirmations.

-Cutoff procedures for inventory purchased should be designed by companies to assure that inventory received before year-end was recorded before year-end.
-Cutoff information for inventory acquisitions should be obtained during the physical observation of inventory

After being disapproved from a vendor because of his company's rating, Sanders ordered his materials through the other comapny he was workiong for and used it for his own business. Whenm this went undetected, he kept doing so. Eventually, another employee noticed this scheme and approached him for as cut of the profits since he was hurting for medical bills. They then reached out to the vendors and cut a deal with them, invoice them more than what was actually delivered, and Sanders and B would split the difference. They kept doing so until they asked for more money from the vendor, who refued. They then created a shell comapny with the two of heir names and addresses and ordered fake goods through their employer to this fake vendor. Theyd again approave the receivables and send payment to themselves. Eventually when Sanders went on vacation and didnt approave the receivables, someone in AP noticed and called the vendor. When she didnt receive an answer, she looked it up and realized it was Sanders home address. She alerted the president of the company right away and criminal investigations began.

Who is responsible for identifying litigation claims and assessments? MANAGEMENT IS

which of these four things will not typically be on a management rep letter?

WILL BE ON EXAM

they can only be done for non-public companies

analytical procedures are performed

limited assurances