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Explain why audits are demanded by society
The demand for auditing is because there is a need for accountability when business owners hire others to manager their business. Auditing is demanded because it plays a valuable role in monitoring contractual relationships between the entity and its stockholders, managers, employees, and debt holders.
Explain Agency Theory (the principal-agent relationship
The growth of the modern corporation led to diverse groups of owners who were not directly involved in running the business (stockholders) and the use of professional managers (agents) hired by the owners to run the company. The owners(principals) provide capital and hires the agent to manage the resources. The agent is accountable to the principal and provides financial reports. The relationship causes information asymmetry, generally the manager knows more about the financials of the business than the owners. This can cause a conflict of interest, the owner may want one thing, while the manager may want another. The manager may not always be in the best interest of the owner. This provides a need for auditing. The role of the auditor is to determine whether the reports prepared by the manager conform to the contract's provisions including the agreed upon accounting principals.
is 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 interested users.
services occur when a practitioner is engaged to issue a report on the subject matter or an assertion about subject matter tat is the responsibility of another party. It is not limited to economic events. Financial statement auditing is a specialized form of an attest service.
independent professional services that improve the quality of information, or its contest, for decision makers. Allows auditors to report not only on the reliability and credibility of information, but also on the relevance and timeliness of that information.
Describe the nature of financial statement audits-
The auditor gathers evidence about the business transactions that have occurred and about management. The auditor uses the evidence to compare the assertions contained in the financial statements to the criteria used by management in preparing them. The auditor's report communicates to the user the degree of correspondence between the assertions and the criteria.
the risk that the auditor may unknowingly fail to appropriately modify his or her opinion on financial statements that are materially misstated.
is the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement.
consists of the underlying accounting data and any additional information available to the auditor, whether originating from the client or externally. The auditor is concerned with the relevance (whether the evidence relates to the specific management assertion being tested) and reliability (the diagnosticity of the evidence) of the evidence. The auditor seldom has the luxury of obtaining completely convincing evidence about the true state of a particular assertion. In most situations the auditor is able to obtain only enough evidence to be persuaded that the assertion is fairly stated.
Discuss the basic financial statement auditing process and phases
Client Acceptance/continuance and establishing an understanding with client, then preliminary engagement activities, then plan the audit, then consider and audit internal controls, then audit business processes and related accounts, then complete the audit, and finally evaluate results and issue audit report.
Describe the content of the standard unqualified auditor's report-
Title, addressee, introductory paragraph (indicates which financial statements are covered by the report, that the statements are the responsibility of management, and that the auditor has a responsibility to express an opinion), the scope paragraph (communicates to the users what an audit entails, the audit provides only reasonable assurance that the financials contain no material misstatements, based on a sample), 3rd paragraph is the opinion paragraph (the auditor's opinion about the fairness of the financial statements based on the audit evidence), the fourth is an explanatory paragraph referring to the audit of internal control, then the signature of the CPA firm doing the audit and the date. To be unqualified, the audit must be done in accordance with applicable standards, the auditor must be independent, there must be no significant limitations imposed on the auditor's procedures, and the client's financial statements must be free of material departures from GAAP.
Qualified Auditor's report
explains that the financial statements are fairly stated except for the misstatement identified by the auditor
Adverse opinion report
if the misstatement is considered so material that it pervasively affects the interpretation of the financial statements the auditor will issue an adverse opinion indicating that the financial statements are not fairly stated and should not be relied upon.
Describe how the credibility of the accounting profession was affected by the large number of companies reporting accounting irregularities in 2001 and 2002
The enron scandal alone weakened investor confidence in the stock market, but the subsequent series of scandals caused a crisis of confidence in the integrity of the entire system of public ownership and accountability in the United States.
Discuss the implications of the Sarbanes-Oxley Act
It transferred authority to set and enforce auditing standards for public company audits to the Public Company Accounting Oversight Board. It also mandated that the SEC impose strict independence rules, prohibiting the provision of many types of nonaudit services to public company audit clients. (Channel 1 vs Channel 2) Audit firms must roll audit partners off an engagement every 5 years, and public companies must get an integrated audit (including audits of both financial statements and internal control over financial reporting)
Understand the high-level model of a business entity and the importance of corporate governance-
5 processes to a business. The organization's accounting information system must be capable of reliably measuring the performance of the business to assess whether objectives are being met and to comply with external reporting requirements. Financial statements which are affected by all the different components of the business model represent an important output of the entity's efforts to measure the organization's performance and accountability.
obtaining capital through borrowing or soliciting investments from owners to invest in assets in accordance with their strategy. Repay lenders and provide a return on owner investments.
HR management process
hire personnel to perform various functions in accordance with the enterprise's missions and strategy. Payroll is the most important part that influences the financials
varies between different business types, includes the cost accounting transactions to accumulate and allocate costs to inventory for manufacturers. There isn't a whole lot in this step for service providers.
sales of goods or services to customers and collecting the proceeds of those sales in cash, either immediately or later with receivables. Management establishes controls to ensure that sales and collection transactions are appropriately handled and recorded. Management identifies risks, or possible threats to the achievement of established objectives and ensures that the organization's systems of internal controls mitigate those risks to acceptable levels.
Private sector audit standard setting for nonpublic companies houses the Auditing Standards Board, prepares and grades the CPA,
government agency oversees the establishment of accounting and auditing standards10K and 10Q filed with SEC
privately funded body whose mission is to establish standards for financial accounting and reporting. FASB=GAAP
private sector nonprofit corporation created by SOX to oversee the auditors of public companies in order to protect the interest of investors and further the public interest in the preparation of informative, fair and independent audit reports. Issues auditing standards for audits of public companies.
auditing standards, General Standards:
1) The auditor must have adequate technical training and proficiency to perform the audit. 2) the auditor must maintain independence in mental attitude in all matters relating to the audit. 3) The auditor must exercise due professional care in the performance of the audit and the preparation of the report.
Standards of field work, (auditing standards)
1) The auditor must adequately plan the work and must properly supervise any assistants. 2) the auditor must obtain a sufficient understanding of the entity and its environment, including its internal control, to assess the risk of material misstatement of the financial statements whether due to error or fraud, and to design the nature, timing, and extent of further audit procedures. 3) The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the financial statements under audit.
Standards of reporting (auditing standards)
1) The auditor must state in the auditor's report whether the financial statements are presented in accordance with GAAP. 2) The auditor must identify in the auditor's report those circumstances in which such principles have not been consistently observed in the current period in relation to the preceding period. 3) When the auditor determines that informative disclosures are not reasonably adequate, the auditor must so state in the auditor's report. 4) The auditor must either express an opinion regarding the financial statements, taken as whole, or state that an opinion cannot be expressed, in the auditor's report. When the auditor cannot express an overall opinion, the auditor should state the reasons therefor in the auditor's report. In all cases where an auditor's name is associated with financial statements, the auditor should clearly indicate the character of the auditor's work, if any, and the degree of responsibility the auditor is taking, in the auditor's report.
Discuss the auditors' responsibility for detecting errors, fraud and illegal acts
Auditors must exercise due care in their work, but the financial statements ultimately are the responsibility of management. The auditor's responsibility is to provide reasonable assurance with respect to errors, fraud, and illegal acts.
determines the extent to which rules, policies, laws, covenants, or government regulations are followed by the entity being audited
involves a systematic review of part or all of the organizations activities to evaluate whether resources are being used effectively and efficiently. Assess performance, identify areas of improvement, and develop recommendations
detect or deter fraud. Business or employee fraud, criminal investigations, shareholder or partner disputes, business economic losses, matrimonial disputes
CPA's Audit financial statements for publicly traded and private companies, partnerships, municipalities, individuals and other types of entities. They may also conduct compliance, operational, and forensic audits for entities if appropriate.
employees of individual companies, partnerships, government agencies, and other entities. Conduct financial, internal control, compliance, operational, and forensic audits within their organizations. They may assist the external auditors with the annual financial audit. They may be involved in assurance and consulting engagements for their entities
employed by federal, state and local agencies. Generally used by the IRS( compliance audits ensuring that individuals and organizations are complying with federal tax laws) or Government Accountability Office ( conduct audits of activities, financial transactions and accounts of the federal government). Also, army audit agency and FBI.
employed by corporations, government agencies, public accounting firms, and consulting and investigating firms. They are trained in detecting, investigating, and deterring fraud and white collar crime
Describe how CPA firms are typically organized and the responsibilities of auditors at the various levels of the organization-
Partner- reaching agreement with the client on the scope of the service to be provided. Ensuring that the audit is properly planned. Ensuring that the audit team has the required skills and experience. Supervising the audit team and reviewing work papers. Signing the audit report. Manager- ensuring the audit is properly planned, including scheduling team members. Supervising the preparation of and approving the audit program. Reviewing workpapers, financial statements, and audit report. Dealing with invoicing and ensuring collection of payment for services. Informing the partner about any auditing or accounting problems incurred. Senior- Assisting in the development of the audit plan. Preparing budgets. Assigning audit tasks to associates and directing the day to day performance of the audit. Supervising and reviewing the work of the associates. Informing the manager about any auditing or accounting problems incurred. Staff - performing the audit procedures assigned to them. Preparing adequate and appropriate documentation of completed work. Informing the senior about any auditing or accounting problems.
refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should interact with others in society. A sense for ethics guides individuals to value more than their own self-interest and to recognize and respect the interests of others as well. Refers to a system or code of conduct based on moral duties and obligations that indicate how an individual should behave in society.
the conduct aims or qualities that characterize or mark a profession or professional person. The concepts of ethical behavior and professional conduct are clearly central to the success of the accounting profession. An accountant that engages in unethical conduct will inevitably harm themselves, others and the profession- Refers to the conduct, aims, or qualities that characterize or mark a profession or professional person
2 parts of the AICPA code of professional conduct
The AICPA, being a private nongovernmental association, only has the authority to require its members to comply with the Code. Not all CPA's are members. Section1- Interpretations of Rules- provides guidelines as to the scope and application of the Rules. and Conduct Section2- Rules of Conduct (defines minimum standards) Starts conceptually and works down to general rules
Principles of professional conduct
responsibility, public interest, integrity, due care, objectivity and independence, scope and nature of service
framework of the rules of conduct
A CPA is required to identify and assess 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. The CPA implements safeguards to eliminate or reduce the threats to an acceptable level or concludes that independence is impaired.
A member in public practice shall be independent in the performance of professional services as required by standards promulgated by bodies designated by the Council.
102- 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 of others.
201- general standards
A member shall comply with the following standards and with any interpretations thereof by bodies designated by the Council. A: Professional Competence B: Due Professional Care C: Planning and supervision D: Sufficient relevant data.
202-compliance with standards
A member who performs auditing, review, compilation, management consulting, tax or other professional services shall comply with standards promulgated by bodies designated by Council.
203 Accounting principles
A member shall not (1) express an opinion that the financial statements or other financial data of any entity presented in conformity with GAAP or (2) state that he or she is not aware of any material modifications that should be made in order for them to be in conformity with GAAP, if such statements or data contain any departure from an accounting principle that has material effect...
301- confidential client info
A member in public practice shall not disclose any confidential client information without the specific consent of the client.
302 contingent fees
A member in public practice shall not (1) perform for a contingent fee any professional service for a client for whom the member or member's firm performs, an audit or review of a financial statement or (2) prepare an original or amended tax return or claim for a tax refund for a contingent fee for any client.
502 advertising and other forms of solicitation
A member in public practice shall not seek to obtain clients by advertising or other forms of solicitation in a manner that is false, misleading or deceptive. Solicitation by the use of coercion, overreaching, or harassing conduct is prohibited.
503- commission and referral fees
A member in public practice shall not for a commission recommend or refer to a client any product or service, or for a commission recommend or refer any product or service to be supplied by a client, or receive commission when the member or the member's firm also performs for that client an audit or review of financial statements. Any member who accepts a referral fee for recommending or referring any service of a CPA to any person or entity or who pays a referral fee to obtain a client shall disclose such acceptance or payment to the client.
505 form of organization and name
A member may practice public accounting only in a form of organization permitted by law or regulation whose characteristics conform to resolutions of the Council. A member shall not practice public accounting under a firm name that is misleading. Names of one or more past owners may be included in the firm name of successor organization. A firm may not designate itself as "members of the AICPA" unless all of its CPA owners are member of the Institute.
purpose of interpretations and ethical rulings
They give a more indepth view of what the rules mean to do. Rulings by the Professional Ethics Executive Committee- interpretations and ethics rulings are not specifically enforceable but an auditor who departs from them has the burden of justifying it.
potential consequences of violating the code
Remedial or corrective actions for non sufficient violations. Expulsion from the AICPA for up to 2 years. State boards have adopted the code a lot of the times, so it could result in losing your CPA.
Identify the 4 general types of situations which impair independence according to the AICPA Code of Professional Conduct
Financial impairment-no financial relationship with a client that may impair or give the appearance of impairing evidence. , managerial (business relationships) impairment-cant perform a managerial or other significant role for a client's organization , family- certain relationships between family members and audit clients are not allowed and litigation-litigation threatened between the client and auditor
Discuss the role and perspective of the SEC regarding independence standards
The SEC's mission is to protect investors and maintain the integrity of the capital markets in which securities of publically traded companies are bought and sold. Has the authority to establish standards relating to financial accounting, auditing and the professional conduct of public accountants. The SEC delegates its authority to set standards for audits of public companies to the PCAOB but the SEC must review and approve the standards.
Explain the relationship between materiality, audit risk and audit evidence
Audit risk is the risk that the auditor may unknowingly fail to appropriately modify the opinion on financial statements that are materially misstated. Materiality is the magnitude of an omission or misstatement of accounting information that, in light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been influenced or changed. Audit evidence is the information gathered or used by the auditor to support his or her opinion.
risk of material misstatement or client risk
inherent risk x control risk. affected by the choices of the client, their business transactions, how much the invest in ic, etc.
inversely related to inherent risk and control risk. If those are high, then detection risk would be low. Effectiveness of the audit procedures, it can never be zero. A low detection risk means more evidence will be needed.
the risk associated with that company. does not take into account the internal controls
the risk that the internal controls will fail. this will always exist because of the inherent limitations of internal controls
Describe the auditor's risk assessment process and procedures-
understand managements objectives and strategies and the related business risks that may result in material misstatement of the financial statements. Understand the entity and its environment, look at internal controls, entity performance measures. Analytical procedures, observation and inspection.
types of fraud
Misstatements arising from fraudulent financial reporting, or misstatements arising from misappropriation of assets (ie- embezzling, stealing assets and causing the entity to pay for goods not received)
fraud risk triangle
why fraud happens- opportunity, incentive/pressure, and attitude/rationalization.
materiality vs. tolerable misstatement
materiality is the magnitude of an omission or misstatement of accounting information that in the light of surrounding circumstances makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement. Tolerable misstatement- the amount of planning materiality that is allocated to an account or class of transactions.
1. The attest function:
A. Is an essential part of every engagement by the CPA, whether performing auditing, tax work, or other services.
B. Includes the preparation of a report of the CPA's findings.
C. Requires a consideration of internal control.
D. Requires a complete review of all transactions during the period under examination.
Before accepting an engagement to audit a new client, an auditor is required to
A. Make inquiries of the predecessor auditor after obtaining the consent of the prospective client.
B. Obtain the prospective client's signature on the engagement letter.
C. Prepare a memorandum setting forth the staffing requirements and documenting the preliminary audit plan.
D. Discuss the management representation letter with the prospective client's audit committee
Which of the following best describes the reason why independent auditors report on financial statements?
A. A management fraud may exist and it is more likely to be detected by independent auditors.
B. Different interests may exist between the company preparing the statements and the persons using the statements.
C. A misstatement of account balances may exist and is generally corrected as the result of the independent auditors' work.
D. Poorly designed internal control may be in existence.
4. Assurance services include which of the following?
A. Preparing a report representing a client's position during an IRS audit.
B. Working with a client to develop a more efficient method of processing financial transactions.
C. Offering an opinion concerning the accuracy of statements made on a client's web site.
D. Assisting a client in identifying potential sources of capital for potential acquisitions.
5. Which of the following best describes a portion of the auditors' responsibility regarding illegal acts by clients?
A. The auditors have a responsibility to discover all material illegal acts.
B. If the auditors suspect illegal acts have been performed, they should conduct a legal audit of the company.
C. If audit procedures reveal illegal acts, the auditors should take appropriate actions.
D. The auditors' responsibility for the detection of all illegal acts is the same as their responsibility regarding material misstatements due to errors and fraud.
6. Which of the following is NOT a requirement of the Sarbanes-Oxley Act?
A. Audit firms cannot provide most types of nonaudit services to their public company audit clients.
B. Audit firms are required to rotate audit partners off audit engagements every five years for public company audits.
C. Firms that audit public companies are subject to inspection by the PCAOB.
D. A certain number of hours, which is based on the size of the company being audited, must be spent on each audit engagement.
7. The fourth standard of reporting requires an auditor to render a report whenever an auditor's name is associated with financial statements. The overall purpose of the fourth standard of reporting is to require that reports
A. State that the examination of financial statements has been conducted in accordance with generally accepted auditing standards.
B. Indicate the character of the auditor's examination and the degree of responsibility assumed by the auditor.
C. Imply that the auditor is independent in fact as well as in appearance with respect to the financial statements under examination.
D. Express whether the accounting principles used in preparing the financial statements have been applied consistently in the period under examination.
8. An investor reading the financial statements of The Sundby Company observes that the statements are
accompanied by an unqualified auditors' report. From this the investor may conclude that:
A. Any disputes over significant accounting issues have been settled to the auditors' satisfaction.
B. The auditors are satisfied that Sundby is operationally efficient.
C. The auditors have ascertained that Sundby's financial statements have been prepared accurately.
D. Informative disclosures in the financial statements but not necessarily in the footnotes are to be regarded as reasonably adequate.
9. Which of the following employees must be independent of an audit client
A. Staff assistants assigned to the engagement.
B. Senior auditors assigned to the office that performs the audit.
C. Managerial employees assigned to an office that does not participate in the engagement.
D. All firm professionals, regardless of position
10. Which of the following acts by a CPA would most likely be a violation of the AICPA Code of Professional Conduct?
A. Assisting a client in preparing a financial forecast.
B. Forming a professional corporation to practice as a CPA.
C. Accepting a fee in a tax matter that is contingent upon the result of an administrative proceeding (court order).
D. Having an immaterial loan to the president of an audit client.
11. In which one of the following situations would a CPA be in violation of the AICPA Code of Professional Conduct in determining a fee?
A. A fee based on whether the CPA's report on the client's financial statements results in the approval of a bank
B. A fee based on the outcome of a bankruptcy proceeding.
C. A fee based on the nature of the service rendered and the CPA's particular expertise instead of the actual
time spent on the engagement.
D. A fee based on the fee charged by the prior auditor.
12. Bill Pan, CPA, has posted the general ledger and has maintained the financial records of Zorko Corporation. As
a part of his responsibilities he has recorded journal entries and made closing entries. Which of the following best summarize the AICPA and SEC views as to the following questions: Is audit independence impaired?
A. No No
B. No Yes
C. Yes No
D. Yes Yes
13. The inspection of a vendor's invoice by the auditor is:
A. Direct evidence about accuracy of a transaction.
B. Physical evidence about occurrence of a transaction.
C. Part of the client's accounting system.
D. Documentary evidence about occurrence of a transaction.
14. Which of the following is generally true about the sufficiency of audit evidence?
A. The amount of evidence that is sufficient varies inversely with the competence of the evidence.
B. The amount of evidence concerning a particular account varies inversely with the materiality of the account.
C. The amount of evidence concerning a particular account varies inversely with the inherent risk of the account.
D. When evidence is competent with respect to an account it is also sufficient.
15. Which of the following is not a primary purpose of audit working papers?
A. To coordinate the examination.
B. To support the financial statements.
C. To assist in the preparation of the audit report.
D. To provide evidence of the audit work performed.
Which of the following statements about evidential matter is not true?
A. External evidence is generally more reliable than internal evidence.
B. Evidence gathered by auditors must be both relevant and reliable to be considered competent.
C. Inquiries of client personnel are not valid evidence.
D. Physical examination is generally more reliable than analytical procedures.
Of the following, which is the least persuasive type of audit evidence?
A. Documents mailed by outsiders to the auditor.
B. Correspondence between the auditor and vendors.
C. Copies of sales invoices inspected by the auditor.
D. Computations made by the auditor
Which of the following procedures would an auditor most likely perform to verify management's assertion of
A. Compare a sample of shipping documents to related sales invoices.
B. Observe the client's distribution of payroll checks.
C. Confirm a sample of recorded receivables by direct communication with the debtors.
D. Review standard bank confirmations for indications of kiting
Which of the following procedures would an auditor most likely include in the initial planning of a financia
A. Obtaining a written representation letter from the client's management.
B. Examining documents to detect illegal acts having a material effect on the financial statements.
C. Considering whether the client's accounting estimates are reasonable in the circumstances.
D. Determining the extent of involvement of the client's internal auditors.
Which of the following audit procedures would be least likely to disclose the existence of related party
transactions of a client during the period under audit?
A. Reading "conflict-of-interest" statements obtained by the client from its management.
B. Scanning accounting records for large transactions at or just prior to the end of the period under audit.
C. Inspecting invoices from law firms.
D. Confirming large purchase and sale transactions with the vendors and/or customers involved.
a letter that formalizes the contract between the auditor and client and outlines the responsibilities of both parties.
audit testing hierarchy
risk assessment procedures, then starts with tests of controls and substantive testing finsishes with remaining assurance needed from tests of details. Fill the bucket
management assertions for Classes of transactions and events for the period under audit
Occurrence, completeness, authorization, accuracy, cutoff, classification
assertions for account balances at the end of the period
existence, rights and obligations, completeness, valuation allocation.
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