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Midterm 1 Short Answer
Terms in this set (12)
What are four requirements of the Sarbanes-Oxley Act that seek to protect auditor independence?
201: services outside the scope of practicing auditors: such as bookkeeping, system design, etc that registered accounting firms may not perform for issuers. However, tax services may be performed with audit committee approval
202: Pre Approval requirements: all audit and nonaudit services must be approved by the audit committee of the issuer
203: audit partner rotation. Lead and reviewing partner must rotate off issuer engagements every 5 years
204: Auditor reports to audit committees: registered accounting firms must report to the audit committee issues concerning
Critical accounting policies/practices
Alternative treatment of financial info within GAAP that have been considered by management as well as preferred treatment of accounting firm
Significant written communications between accounting firm and management
Describe four responsibilities of audit committees as mandated by SOX and/or the NYSE.
As mandated by NYSE:
Discussing the company's financial statements with management and the external auditor
Discussing in its meetings policies with respect to risk assessment and risk management
Setting clear hiring policies for employees or former employees of the external auditor
Reporting regularly to the BOD
What are the steps in management's evaluation of internal control over financial reporting?
Identify Financial Reporting Risks and Controls Implemented to Mitigate those Risks
Evaluate the Operating Effectiveness of Internal Control over Financial Reporting
Provide Report on Effectiveness of Internal Control over Financial Reporting
What are the three types of law that are relevant to auditors' legal liability? Explain the causes of legal action under each type.
Contract law: Occurs with a breach of contract:
(1. Violating client confidentiality 2. Failing to provide audit report on time 3. Failing to discover a material error or employee fraud 4. Withdrawing from an audit engagement without justification)
Common Law: based on negligent or fraud to third parties: (1.Ordinary Negligence- failure to exercise reasonable care 2. Gross Negligence-failure to exercise minimal care 3.Fraud- intentional concealment or misrepresentation of a material fact)
Statutory law: laws passed by governmental units and includes federal securities laws and state statutes (Securities Act of 1933 AND 1934 and SOX Act of 2002)
What are the seven AICPA's fundamental principles that govern audits?
Purpose of an audit is to enhance the degree of confidence that users can place in the financial statements and is achieved when an auditor expresses an opinion on the financial statements
Audit is based on the premise that management has responsibility to prepare the financials, maintain internal control over financial reporting, and provide the auditor with relevant info and access to personnel
Auditors are responsible for having the appropriate competence and capabilities to perform the audit, should comply with ethical requirements, and maintain professional skepticism throughout audit
Auditor needs to obtain reasonable assurance as to whether the financial statements are free from material misstatement
Obtaining reasonable assurance requires the auditor to plan and supervise the work, determine materiality levels, identify risks of material misstatement, and design and implement appropriate audit responses to the assessed risks
An audit has inherent limitations such that the auditor is not able to obtain absolute assurance about whether the financial statements are free from misstatement
The auditor expresses an opinion as to whether the financial statements are free of material misstatement or states that an opinion cannot be expressed
Identify the five phases involved in the audit opinion formulation process.
1.Making Client Acceptance and Continuance Decisions
2.Performing Risk Assessment
3.Obtaining Evidence about Internal Control Operating Effectiveness
4.Obtaining Substantive Evidence About Accounts, Disclosures, and Assertions
5.Completing the Audit and Making Reporting Decisions
Identify and describe the five management assertions inherent in financial statement. Provide two examples of each.
Existence: addresses whether all assets/liabilities/etc. Recorded in the statements exist, looking for overstatements of ending balances
Touring the plant to determine a major equipment acquisition was received
Perform inspection and independently count a sample of the client's marketable securities held in a safe deposit box
Completeness:Addresses whether all transactions/accounts that should be included in the statements are included, looking for understatements of ending balances
Select source document for legal expense and determine that expenses were appropriately expensed
Selecting source documents for materials received and determine that payables were recorded in the appropriate time, not delayed
Rights/Obligations: Addresses whether recorded assets and liabilities are the rights and obligations of the organization
Inspecting Inventory Warehouse for goods on consignment or ending inventory to which the organization does not have legal title and determine that they were not included on financial statements as their own.
Inspect documents related to lease contracts
Valuations/Allocations: Addresses whether accounts have been included in the financial statements at appropriate amounts
Determine that estimated life and salvage value are consistent with similar purchases, policies, expected future use and past experience
Develop an expectation of total depreciation using analytical procedures
Presentation/Disclosure: Addresses whether components of the financial statements are properly classified, described, and disclosed
Review disclosures to ensure that they are adequate and understandable
Review presentation within financial statements to ensure completeness and conformance with the applicable financial reporting framework
What are the three broad types of audit procedures? What is the purpose of each test?
Risk Assessment Procedures: Obtain information for identifying and assessing the risks of material misstatement in the financial statements whether due to error or fraud
Test of Controls: evaluate the operating effectiveness of each control in preventing, or detecting and correcting material misstatements
Substantive Procedures: determine whether material misstatements exist in the financial statements
Identify at least five specific procedures an auditor can apply to collect audit evidence and provide an example of each.
Inspection of assets: Touring the manufacturing facility and inspecting equipment
Recalculation: Recalculate the total amount included on a sales invoice
Inspection of documentation: Review shipping documents as evidence of a sale having occurred
Reperformance: Reperform a reconciliation performed by client personnel
Observation: Observe whether controls designated to limit access to a secure area are functioning
Audit documentation serves as the primary support of an audit. Give six examples of the components of proper working paper documentation.
Initials/electronic signature of auditor performing audit test and the date the test was completed
Tick marks and a tick mark legend indicating the nature of the work performed by auditor
A section that identifies all significant issues that arose during the audit and how they were resolved
A description of the tests performed (including the items looked at) and the findings
Heading that includes name of audit client, an explanatory title and the balance sheet date
A unique workpaper page number
The Auditing Standards Board established guidelines to assist auditors in evaluating the reliability of audit evidence. Discuss the criteria for the more reliable types of evidence and include an example for each.
Directly obtained evidence (ex: observation of a control)
Evidence derived from a well-controlled information system
Evidence from independent outside sources (ex: a requested statement from a customer)
Evidence that exists in documentary form (ex: an A/P aging schedule instead of inquiry about A/P)
Evidence from original documents (ex: physical original copy of invoices instead of digitized PDF form)
Identify and explain the audit assertions relevant to an audit of cash balances in a financial statement audit. For each assertion, provide one distinct example of an approach that can be used to obtain audit evidence.
Existence that all recorded cash on statements exists: External confirmation of balances in cash accounts from banks
Completeness that all existing cash is recorded on the statements accurately and completely: Inspection of physical petty cash box
Rights/Obligations that the cash is owned by the company: External confirmation that securities are of the company's ownership
Valuation/Allocation that cash balances are valued accurately: Recalculation of discounts taken on invoices paid within the payment terms
Presentation/Disclosure of cash balances in the timing of procedures: Scanning of the ledgers and journals to confirm that all cash transactions are appropriately recorded before the cutoff
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