Auditing Final - Chapter 14

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Inherent Risk Assessment - Prepaid Expenses

Generally assessed as low because the accounts do not involve any complex or contentious accounting issues

Control Risk Assessment - Prepaid Expenses

Because prepaid expenses are normally processed through the purchasing process, control procedures in purchasing should ensure that each item is properly authorized and recorded

Substantive Procedures to test for Prepaid Expenses

Audit testing begins by obtaining a detail schedule of the prepaid insurance account

Test for Existence and Completion for Prepaid Expenses

Confirm policy with insurance broker, examine supporting source documents

Test for Rights and Obligations for Prepaid Expenses

Confirm policy beneficiary with the insurance broker

Test for Valuation for Prepaid Expenses

Determine unexpired portion of policy and insurance expense

Test for Classification for Prepaid Expenses

Determine propriety of distribution between manufacturing overhead and SG&A expense

Test of Controls of Substantive test of Prepaid Expenses can simultaneously test...

B/S and I/S

Inherent Risk Assessment - Intangible Asset

-The nature of intangible assets raises serious inherent risk considerations
-The accounting rules are complex and the transactions are difficult to audit
-Account standards require different asset impairment tests for different classes of intangible assets (FAS142/ASC Topic 350)
-With the judgement and complexity association with valuation and estimation of intangible assets, the auditor would likely assess the inherent risk as high

Control Risk Assessment - Intangible Assets

Factors for Auditor to Consider:
1. The expertise and experience of those determining the fair value of the assets
2. Controls over the process used to determine fair value measurements, including contols over data and segregation of duties between those committing the client to the purchase and those undertaking the valuations
3. The extent to which the entity engages or employs valuation specialists
4. The significant management assumptions used in determining fair value
5. The integrity of change controls and security procedures for valuation models and relevant information systems, including approval processes (AU 328)

Substantive Procedures for Testing Intangible Assets

-Tests of details associated with valuation and impairment of intangible assets are often necessary because the complexity and degree of judgment increase the risk of material misstatement
-Summary: intangible assets are complex and are high risk accounts
-Some substantive evidence is required for all significant accounts, and substantive analytical procedures are not likely to provide sufficient, appropriate evidence for significant transactions involving intangible assets.
-Summary: need to get some substantive evidence, but does not provides sufficient to draw conclusion

Four assertions are normally considered for tests of details of intangible assets:

1.Existence and completeness
3.Rights and obligations

Auditing Property Management Process

Property, plant, and equipment usually represents a material amount in the financial statements

Recurring Engagement

The auditor is able to focus on additions and retirements in the current period because amounts from prior periods have been subject to audit procedures

New Engagement

The auditor has to verify the assets that make up the beginning balance in property, plant, and equipment

Types of Transactions for PPE:

1. Acquisition of capital assets for cash or other nonmonetary considerations
2. Disposition of capital assets through sale, exchange, retirement, or abandonment
3. Depreciation of capital assets over their useful economic life
4. Leasing of capital assets

Inherent Risk in the Property Management Process-3 Inherent Risk Factors Auditor must consider:

1. Complex Accounting Issues
2. Difficulty to Audit transactions
3. Misstatements Detected in Prior

Control Risk Assessment - for PP&E

Segregation of Duties
1. Initiation Function//Final Approval Function
2. PPE Recording//General Ledger Account
3. PPE Recording//Custody of Assets
4. Inventory Counters//Custodial Record Keeping Functions

Initiation Function//Final Approval Function

A. Fictitious or unauthorized purchases of assets can occur
B. Purchase could be below standards, unnecessary assets, or illegal payments to suppliers

PPE Recording//General Ledger Account

Potential for defalcations that would normally be detected but substantive procedures

PPE Recording//Custody of Assets

Items can potentially be stolen, and theft concealed by adj. of acct. records

Inventory Counters//Custodial Record Keeping Functions

Theft of the entity's capital assets can be concealed

Test for Occurrence and Authorization - PPE

-Control procedures for the occurrence and authorization of PPE are normally part of the purchasing process
-However, large capital asset transactions may be subject to additional controls
-Remedy is that companies should have an authorization table for approving capital asset transactions

Test for Completeness - PPE

The detailed PPE subsidiary ledger usually includes the following information for each capital asset:
1. Description, location, and ID number
2. Date of acquisition and installed cost
3. Depreciation methods for book and tax purposes salvage value, and estimated useful life

Substantive Analytical Procedures for PPE

1.Compare prior-year balances in PPE and depreciation expense with current-year balances
2.Compute the ratio of depreciation expense to the related PPE accounts and compare to prior years' ratios
3.Compute the ratio of repairs and maintenance expense to the related PPE accounts and compare to prior years' ratios
4.Compute the ratio of insurance expense to related PPE accounts and compare to prior years' ratio
5.Review capital budgets and compare the amounts spent with amounts budgeted

Test for Completeness and Accuracy of PPE

-The auditor begins the process by obtaining a lead schedule and detailed schedules of additions and dispositions of assets (Rollforward format is common)
-These schedules are footed and agreed to the general ledger
-The auditor can trace a sample of assets to the PPE subsidiary ledger

Test for Cutoff of PPE

-Cutoff is normally part of the accounts payable and accrued expenses work
-Vendor's invoices from a few days before and after year-end are examined to determine if the assets are recorded in the proper accounting period

Test for Classification of PPE

-First, the auditor must determine that the capital asset is recorded in the proper account
-Second, the repairs and maintenance account should be reviewed to determine if any capital assets have been incorrectly recorded in these accounts
-Finally, each material lease agreement should be reviewed for proper classification as operating or capital lease

Test for Existence of PPE

-A list of all major additions should be obtained and each addition should be vouched to supporting documentation
-For major acquisitions, the auditor may physically examine the capital asset. This is often done during the inventory observation
-Major dispositions should be vouched to supporting documentation and examined for proper authorization

Test for Rights and Obligations of PPE

-In most cases, rights or ownership can be determined by examining vendor's invoices and other supporting documents
-In some cases, the auditor may with to confirm property deeds or title documentation

Test for Valuation and Allocation of PPE

-Capital assets are valued at acquisition cost plus any costs necessary to make the asset operational. The auditor tests the recorded cost of major new additions to PPE
-The auditor may recompute, either manually or with the aid of a computer, the proper depreciation expense for the period
-The auditor must test for permanent impairment of long-lived assets. While GAAP requires the comparison of future cash inflows to the asset's carrying amount, this process can be quite difficult. Auditors may look to other sources of information to learn about impairments

Test for Disclosure of PPE

-Examples of disclosure items:
1. Classes of capital assets and valuation bases
2. Depreciation methods and useful lives for financial reporting and tax purposes
3. Non-operating assets
4. Construction or purchase commitments
5. Lien and mortgages
6. Acquisition or disposal of major operating facilities
7. Capitalized and other lease arrangements

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