1important to ear mark why cash was not a fund(???) file page 116
file page 118 traces to textbook page 214(???). this is a substantive analytical test. fixed assets are grouped by categories based on their depreciable lives, testing is done on groups to save time and money.
2significant audit risk exists in every audit engagement. once we determine there is a significant audit risk, we need to find the relevant controls to that risk and...
we must have brainstorming sessions involving as many audit engagement specialists as possible to determine if theres fraud (allows more experienced managers and partners to give their perspectives).
3textbook page 214 is a memo for inventory evaluation at year end. just a summary of procedures supporting schedule.
current and noncurrent permanent files -not in textbook? look at file page 125.
4bulk files are uncommon, can be electornic. these are typically clean files.
if you dont need it to support the audit opiniion, you must destroy files up to 60 days after audit report release date.
5au-c 230 AQR audit quality review (.03)
as former auditors, we allow successor auditors access to client work papers. do not change audit documentation after report release date UNLESS you can justify it.
6if nothing is compensatory, you need to do the tests
analytical procedure applied ...when something doesnt look right to prior years.
7things need to be meaningfully correlated. if theyre not, its spersly correlated (like eating icecream is corrlated with drownings...spersly correlated because its not really meaningfully correlated)
staff are the eyes on the audit-if you see something, say something! ask questions if theres something fishy (ask your senior, then manager).
8if ending inventory is overstated, income is overstated.
SEC codes: ratios provided by industry standard (averages across the board) to compare to your client's numbers to see if they align or are way off.
9how to link financial information to nonfinancial information:
run similar ratios across the board to all business locations
107-8 ways to do forensic analysis (???)
analytics should be done during the planning stage
11AUC 520 .A7-9 .A
what is more effective? taking a huge sample size to find a fradulent check or looking into payroll per pay period for the large jump.
12Data is more:
-Predictable (AUC 520.A10)
-Reliable (AUC 520.A17)
those lead to more precise expectations.
13Aggregated = 144 instances (12 transactions a month). Disaggregated = 12 instances (monthly groups). the better option in looking for 15 transactions would be to use the disaggregated, as 15/12 is a more precise expectation(???) than 15/144.
14Engagement Letters (AU 210)
Contract to the audit between the client and the CPA firm. What they're going to do, responsibilities, etc.
15Related Party Transactions (AU 550)
Transactions entered into between the audit client and officers and directors, equity method investees, ...
16Using the Work of a Specialist in an Audit (AU 620)
Grab an industry audit person from that industry. They'll tell you how accounting principles are unique to that industry. Shows how auditors would audit those principles differently. Example, oil industry must include how much oil they have in reserves in the footnotes to financials...you'd need to engage an expert to confirm those footnotes.
17Communications between Predecessor and Successor Auditors (AU 510.12, 510.A1-.A18, and exhibits B and C)
This is for any audit change, public or private. Things the potential successor must do before taking on the client.
18Limited indemnification clause: 1136 Tenants vs. Rothenberg, CPA's
now related parties are needed to be disclosed on the financial statements
19Margin trading is this. You wanna buy 10k stock through your broker. Federal margin requirements mean you have to pay down 5k to your broker. If the stock goes up to say 12k, you could owe your broker 6k. If it goes down to 8k, you may owe your broker less (4k).
3 key elements to keep in mind with related parties transactions:
1. assumed not "at arm's length" (both party's have free will to make a decision without being threatened or under diress)
2. quality of reported earnings is suspected to be questioned (gaining earnings without threatening or causing diress)
3. be especially weary of "economic substance vs. literal or even legal FORM" of transactions
20substance vs. form
most important thing you could ever learn as an accountant and auditor. a lot of these enigmas have been solved or us by FASB.
example: if it walks and talks like a duck, its a duck as of substance. you cant say it isnt because theres mud on its foot, thats form.
21(example of substance vs. form issue in real world) Insurance Company Profits
1. underwriting profits (premiums earned less losses paid out)
2. investment profits
bad year with a lot of losses. now they rely on investment profits to keep earnings up.
every year they'd debit ??? and credit unrealized appreciation in marketable securities. they then sold the securities for a bump in profits.
however, they bought them back as soon as they sold them. substance means, they didnt really sell anything. logically, rationally, you can't do that. (some partners will allow this if you disclose it in the statements that you did this tomfoolery)
22any time theres a related party transaction
1. whats the nature of the relationship
2. description of the transaction undertaken
3. dollar volume of those transactions
4. any amount due, to, or from party
if they follow these provisions, they can get an unmodified opinion. cannot imply its arms length when it isnt. if they do, its an AFRF departure qualified opinion.
23Paid in Capital when the profit is way too high, the fair price is well below how much they sold it for. Not all of it is gain, the appropriate portion is the gain and the rest is paid in capital.
real situation involving a public company:
public company develops patents and sells them. price ranges from $10k to $100k as well as royalties from the patents' use.
they then sell a patent for $2mil to Cord Inc. they have verified check for $2mil. Cord Inc borrowed $2mil from the bank through as a shell company. turns out, the patent was worthless and they documented $1.99mil in profit.
WHAT SHOULD THE AUDITOR HAVE DONE?
- inquire on who is Cord Inc and who runs it/owns it?
- check out the articles of incorporation and check with attorney for validity of incorporation contract
- drive by the business location to verify its legitimate
- did the client (patent seller) seek other legitimate bids for this patent?
the auditors adjustment is this amount is not a gain but rather paid in capital from Cord Inc if they will be paying. if not, then its to the notes payable for the $2mil that will need to be paid back to the bank for the loan.
24audit report release date is the date we allow the client to use the audit report in conjunction with their other financial statements. all audit files must be finalized within 60 days of the audit report date (most of the big four firms do this within 5 days)
purpose of work papers is for the purposes of an experienced auditor.
25when would you depart from a presumptively mandatory requirement?
rarely, we might but should indicate what we did alternatively and how we obtained sufficient audit evidence for that.
26do not modify existing audit documentation after the report date. if so, document when and who made the changes.
whenever possible, you want the audit report and release date to be the same.
27every work paper does not have to be signed off by a reviewer. you could have a binder of work papers and the manager, senior, etc. could sign off the whole binder.
after the audit report is out, file documentation completion can be administrative only, you cant do any more tests or draw new conclusions.
28pcaob requires retention of audit files for 7 years. audit papers are the property of the auditor, they may be made available to the client (copies without showing what the testing was) but are property of the auditor.
basic concepts of controls over existence and occurance etc. are equally applied to manual or highly automated systems.
29when you get into highly complex IT systems, IT auditors are needed to perform two key functions:
1. test IT system controls
2. making sure their data theyre entering in testing is kicked out of the system and not messing up other aspects of the complex IT
because data may not be available for testing at certain points in time, we might delay the testing when the data is available
30What needs to be communicated with governance?
-The auditor's responsibilities under GAAS
-Providing a copy of the engagement letter to governance
-Significant adoption or change in accounting principles
-Often tenuous nature of accounting estimates
-Planned scope and timing of the audit (important not to compromise the effectiveness of the audit)
-Significant audit adjustments, whether or not recorded
-Unrecorded audit differences, other than those considered trivial, considered by management to be immaterial
-Significant deficiencies and material weaknesses in internal controls
-Auditor responsibilities under Au-C 720
-Methods of accounting for significant unusualy transactions and controversial or emerging areas for which there is a lack of authoritative guidance
-Disagreements with management
-Serious dificulties encounrtered in dealing iwth management during the audit
-Candid discussions about quality, not just minimum acceptability (show us in a textbook where it says we cant do this!)
-Management's consultation with other accountants
-Significant issues discussed with management
-Fraud and illegal acts
-Management representations were obtained
31Auditor Specialist vs Management Specialist
Auditor Specialist:
-Internal (works for CPA firm)
-External (does not work for CPA firm)
Management Specialist
-Hired by client
32Only time to refer to an external specialist - only if it's an unclean opinion and this will specify why it is an unclean opinion
not specialist if responding to attorneys letter, but as far as contractual agreements they are a specialist.
accounting functions are not specialist functions.
an external specialist must be assessed fir competence, capability, and independent/objective of the situation and client.
33if the specialist is unsure, it is a scope problem. if the specialist has a different opinion than the client's and wont change it, then it is an AFRF departure.
look at chapter 8 video 4.
34inherent risk in a transactino cycle is
auditors objective assessment is there could be an error in that transaction cycle in the absence of any internal controls (separate aspect).
low detection risk is good, means we can do less audit testing.
page 285 expanding on chapter 9 ...something
35two concepts for quantitative materiality
-...materiality takes financial statements taken as a whole
-performance materiality is less than the whole financial statements.
36known vs likely misstatement
need to keep record of items that are more than trivial but less than material. these need to be included on the rep letter given to the client.
37clarified audit risk model.pdf (canvas)
audit risk is set for the entire audit. our concern is with Type II error.
38"Audit SS inv. components as a sample from 2,000"
inv year end @ (950,000-$1,100,000) 95%
sampling error
39typical audit risk is 5% (intuitively)....why not audit more conclusively to 2%? it simply isnt worth the cost to the client or society for the amount of testing that would need to be done.
however, you will want to reduce it as much as possible (1933 Act Filing IPO) checking the S1 since it is very high risk. auditors are held liable for ordinary negligence if there are issues with this 1933 S1 laws.
40Internal Controls are two types:
-Preventative: transaction level controls
-Detective: population internal controls (audit bank reconciliation form)
Which is more important? Preventative. This is now required due to Sarbane's Oxley Act.
What does an auditor prefer to check? Detective. It's easier.
Current notion is find something you can test as intenral controls (don't say, we didnt test controls they didnt have any!)
41 CA3* DR/ ... = AR / IR CR
If IR and CR go down, CA3* DR will go up. It is an inverse relationship.
* means acceptable
42Apply your tests closer to balance sheet date. You raise the audit risk by virtue of not looking at the last month or two in an area.
things with obscelence risk are riskier than a company that does not deal in obscelecence. new accounts are risky.
related parties transactions increase inherent risk.
43if inherent and control risk are going in different directions, you need to look at what level of audit risk you want to achieve.
[A]DR = AR / IR x CR
low AR means burden of proof lies on experts.
low IR means it isnt likely theres any material misstatements.
CR is high, we might not catch something in a timely basis.
RMM is the interation of IR x CR. if one is high and the other is low, together they're medium. this leads [A]DR to be medium...but we override this and say [A]DR needs to be loooow.
44work through problem 9-34 and 37 before class next tuesday...this WILL BE ON EXAM
FASB tried to define materiality but could not, determined its a matter of auditor's judgment
45why do CPA firms use quantitative measures over qualitative?
inexperienced seniors can plug numbers from the statements into a formula, intrafirm consistency is desireable and different firms come to similar materiality amounts.
46figure 8-6 in textbook for determining materiality
page 141 in course packet
47anytime FASB issues altimative that effects earnings or revenues - earnings drop dramatically. big buying opportunity a year after this.
based materiality on the average of the prior 3 years earnings or revenues and applying your 6% to that number rather than to current cont. ops. (course packet 142). we then chose the most conservative materiality number to apply (lowest number after comparing based on total assets and revenues and earniings etc)
48uncorrected - amounts that werent corrected due to it not meeting materiality criteria in the past.
maintain a running total of adjustments that are less than material that the client did not want to book. this must be included as an attachment to the rep letter to governance. it does not create a qualified opinion, unless aggregated it is material. they then need to book an amount that gets up to the materiality criteria level.
adjustments / adjustments passed (ones not made). two different work papers.
49auditor not need to keep record of trivial items. plannning vs. performance materiality is important here.
1. whats the purpose for deriving Performance MAteriality from Planning MAteriality?
its a cushion for uncorrected and undetected misstatements in the audit.
50Planning materiality = $128,000
summation of adjustments passed (S.A.D.) in the audit, we didnt make the client book these because they were immaterial. it would have been reducing income = $80,000 if they were booked.
cushion for undetected misstatements and trivial items (things we have no record of) ...how big would this need to be? = ...$48,000 ($128,000-$80,000) and debit to earnings effect
(course packet page 143)
Controls ineffective audit:
Performance Material = 50% x Planning Materiality = $74,000 ($128,000 x 50%)
51likely misstatement is compared to materiality, not the known misstatement. you'll take the known and extrapolate it to the whole population to get the likely misstatement, thats what gets compared to materiality criteria.
when adjusting, we only adjust the known misstatement.
52what do you do in following year when error is found in previous year? standards say, these two are additive, so include the prior period error with the current year error and then it may become material, and would need to be adjusted.
prior period likely error will affect following year financials.
53are auditing adjustments prior period adjustments? NO.
qualitative means if its immaterial quantitatively, but it reflects on the ethics and what else the client may do. sets the tone at the top to trickle down if the CFO/CEO is doing things incorrectly.
54bond indenture agreement - current ratio cannot go below 3/2
client has is $1 million in current assets
client has $25,000 acct. rec. that hasnt been resolved.
does the client need to write off the uncollectible $25,000?
its immaterial, however not writing it off is resulting in the current ratio being incorrect which is violating the bond indenture agreeement and the auditor cannot aid and abbett this violation.
this is a qualitative issue.
Au-C 450.A28 check it out!!
55bad cash controls lead to lapping, lapping is...
b's money applied to a's account.
56how does an auditor catch lapping?
key - take the checks received that day. you want to see the check applied to the correct account (making sure for example smith's check is applied to smith's account)
57never let AR bookkeepers under any circumstances approve bad debt write offs (small business)
important substantive analytical test to check for overstated sales, receivables, etc. (course packet page 177) ...look at unusual fluctiuations from previous year, within the months of the audit year, in conjunctin for the total of the year. gross profit test is name for this type of testing.
it is substantive because we used account level data.
58 (slide 6 in powerpoint 13)
therefore year end substantive testing of BALANCE SHEET ACCOUNTS can be reduced
59better to test controls rather than test dollar amounts. ?
Financial statements
v
General ledger
v
Sales and collection cycle testing for completeness:
1. Source document (could be external, more reliable)
2. Sales invoices (internal)
3. Recorded entry (internal)
Sales and collection cycle testing for occurence:
1. Recorded entry (internal)
2. Sales invoices
3. Source document (could be external, more reliable)
does it make sense to test in both directions? NO. completeness and occurence assertions dont happen at the same time... also occurence is less risky so using gross profit test of the sales accounts work just fine.
60control environment is the most important component of the five components of internal control. (COSO control criteria)
tables 13-6 and figure 13-9 in the textbook are very helpful to tie together several parts of the audit.
61homework 9-37 will be on exam. test
audit standards article on course packet page 148 summarizes a lot of AU-C 315 and 330.
62get evidence in different ways each year, incorporating elements of unpredictability in the audit process.
we can no longer default to control risk maximum without support.
63test question: cycle rotation testing of controls
we have 5 possible transaction cycles. out of these 5, which might an audit client not have?
an answer could be inventory conversion cycle, because a service industry will not have significant inventory.
we're not going to test controls in every single cycle every single year, which becomes cycle rotation testing of controls based on previous years risk (especially if previous years controls were tested and have not changed in the new year. even if things dont change, we need to test them every 3 years.
64you must always perform some substantive tests of balances or analytically of year end balances no matter how good controls are. you must always do some substantive testing of year end balances. every system of controls can have inherent limitations, such as collusion or fraud. control risk can never be zero. THIS WILL BE ON THE EXAM.
if you find significant risk, you must do substantive testing of those risks. you also must test effectiveness of controls relating to those significant risks every year, you cannot use cycle rotation testing of controls in this scenario.
65active owner-manager involvment is important in small businessses as a form of compensating control where there might otherwise not be many controls.
AU-C 330 (I think?) A.75 and A.77 are important areas in the difference between testing controls between manual and automated controls.
66if testing an automated control, and have tested it at least once, that is sufficient for testing controls in an automated IT system. if its doing what it should do at that point in time, itll be doing it again and again. this works if general controls are good (people cant alter the IT automated controls).
inquiry alone is not sufficient to count as "testing controls".
67course packet page 160 (answers):
1. this is a custody function. therefore under treasury area.
2. this is another custody function, so it should belong to the treasury function.
3. data-entry function. this goes to general accounting. dont want treasury or warehouse to do this because theyll have access to the assets.
do not comingle custody with data entry.
68why do we need to tell governance about control problems even when they've been fixed? governance needs to address why their management hasnt fixed this before the audit. also, once theyre fixed, we wont be able to go back and test the controls at that point especially during busy season.
all communications with governance needs to be in writing, not orally.
69significant deficiencies in material weakness. alpha 11 has 4 examples of material weaknesses in controls. LOOK FOR THIS ON EXAM.
1. restatement of previously issued financials due to an error, but not due to application of a new fasb standard.
2. identification of a fraud whether or not material on higher level management
3. identification of a misstatement that appears controls were not going to detect, or did not detect
4. ineffective oversight by governance
still write up deficiencies in material weaknesses even if management doesnt fix it.
70suggest to management how to fix controls problems or deficiencies problems reported to them.
"we considered controls, we express no opinion on the effectiveness of controls. there's areas we may not look into and there could be significant deficienciesi n those areas that we do not find."
71report on controls problem is intended solely for management, governance, or governmental agencies that are required a copy for funding. this is a restricting paragraph that shows others are not allowed to see this (banks, creditors, etc).